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Could you please explain how can I arrive at the 6.2% required return to ensure shareholders’ wealth is not affected? Thank you in advance.
The debt is increasing by $1600 and the PBIT needs to increase by $99.14M
99.14 / 1600 = 6.2%
Dear Mr Moffat,
It relates to question Jupiter, December 2008. It said that “the free cashflow to equity model has provided a reasonable estimate of the company equity market valuation in the past” but we will have to understand that it will be correct to use the model to evaluate the valuation in the future as the answer provided in part (c). Is it correct?
Also, please would you help me to understand why the earnings growth rate 4% is not used to calculate the value after the capital restructure but by taking from 30% retention earned at the cost of equity?
Besides, I am wondering if I am supposed not to ask too much so that the other students can ask you then? (sorry for this silly question but I’m afraid people think I am rude or there is rule that I have not been aware before posting the questions here).
Many thanks.
HanhDear Mr Moffat,
Another question in relation to part (c) is that the answer does the “back work” to convert the free cash flow (FCFE) from into the pretax by dividing to 0.75. However, as the FCFE is after interest, tax and reinvestment so if we divide it by 0.75 the result will not the PBT. It makes me confusing….Please help.
Thanks
Hanh
With regard to FCFE – yes. The fact that the question said it had worked in the past implies that you should use it to answer the question.
There is an argument for using 4% as growth, and you would have got the marks if you had have used 4% instead of using Gordon’s growth approximation.
For part (c) BPP have (correctly) divided by 0.75 to get the profit before tax, and have then added the interest to get the profit before tax and interest.
But if the growth rate 4% was used then the FCFE would be lower than the it is before the new loan introduced to replace the current loan. Thus there will be a reduction in the PBIT?
That is true. (There is rarely just one correct answer for P4 questions. It depends on your assumptions, which is why you must state your assumptions. If your assumptions are sensible then you still get the marks.)
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