Attempt ALL questions.
Question 1 – Capital structure
Accommodate plc is a hospitality company that owns a chain of hotels in the
UK. The company is considering the acquisition of a number of fitness
centres to expand its operations. The Finance Director has been asked to
evaluate the project.
The investment would cost £20 million, which would be payable immediately.
The investment is expected to generate pre-tax earnings of £1.2 million for
the first year, £2.3 million for the second year, and £2million for each year
thereafter.
The investment will be financed by 30% equity and 70% debt, which is in line
with Accommodate’s existing capital structure. Due to a government initiative,
some of the debt will be raised by a subsidised loan, however, the details are
yet to be determined.
Accommodate’s current weighted average cost of capital (WACC) is 9%, and
their pre-tax cost of debt is equal to the risk-free rate of 2%. The expected
market return is currently 6%.

The Finance Director of Accommodate plc has obtained the equity and debt
betas and the gearing ratio of a proxy company, for the purposes of project
appraisal, these are: –
Equity Debt Gearing ratio
beta beta (debt: equity)
Active plc 1.2 0 1:2
Assume that the marginal rate of corporate tax is 20%.
Required:
a) Calculate the risk-adjusted WACC for Accommodate plc using Active plc
as a proxy company.
(10 marks)
b) Calculate the NPV for the project, using the risk-adjusted WACC as the
cost of capital. Suggest whether the project should be accepted.
(3 marks)
c) Describe the benefits and limitations of using the WACC, risk-adjusted
WACC and adjusted present value approaches to appraise the project.
(Maximum wordcount: 240 words)
(12 marks)
TOTAL 25 MARKS

Question 2 – Dividends
Stott Plc (Stott) has £150 million in excess cash and no debt. The firm
expects to generate additional free cash flows of £105 million per year in
subsequent years and will pay out these future free cash flows as regular
dividends.
Stott’s unlevered cost of capital is 6% and the company presently has 6
million shares outstanding. Stott’s board is meeting to decide whether to pay
out its £150 million in excess cash as a special dividend or to use it to
repurchase shares of the firm’s stock.
As some preliminary calculations to assist the board meeting you have been
tasked with answering the following: –
a) What is the cum dividend price, the regular future annual dividend and the
current market value of Stott?
(4 marks)
b) Assume that Stott uses the entire £150 million in excess cash to pay a
special dividend. What will Stott Plc’s ex-dividend price be?
(2 marks)
c) Assume that Stott uses the entire £150 million to repurchase shares at the
cum div price calculated in (a) and answer the following: –

i. What is the number of repurchased shares?
(Round to the nearest share)
(2 mark)
ii. What is the number of outstanding shares?
(2 mark)
iii. What is the amount of regular yearly dividends in the future?
(2 mark)
iv. Calculate the share price after the repurchase.
(2 mark)
d) The board of Pawson plc is considering changing from its current dividend
policy of paying out what is left over from its available cash after making
investments. The forecast dividends if the company continues with its
current policy and the forecast dividends if it changes to the new policy
are shown below.

Forecast dividend payments 1 – If current dividend policy continues
Year 2020 2021 2022 2023 2024
Dividend
per share
(pence)
20 36 42 47 48

Forecast dividend payments 2 – If new policy is employed
Year 2020 2021 2022 2023 2024
Dividend
per share
(pence)
20 25 31 39 48
Explain which dividend policy Pawson is currently using and the advantages
and disadvantages of the policy. Explain which policy is being employed in
the new proposal and explain the advantages and disadvantages of the
policy.
(Maximum wordcount: 220 words)
(11 marks)

Question 3 – Mergers and Acquisitions
Required:
For the following methods of evaluating companies for the purpose of
Mergers and Acquisitions, describe each method, explain the how the
calculation for each method is performed and discuss the value and
application of the method.
 Net asset valuation
 P/E ratio valuation
 Free cash flow valuation
Note: Use numerical examples to support your answer where appropriate (10
marks available for Calculations)
(Maximum wordcount: 300 words)

Question 4 – Options
You are working for an investment firm in the City of London and have been
asked to perform some analysis of the European-style call options of a
company called Elevation Matters Plc (EM).
The most recent closing share price for EM was £38. The risk-free rate is 3%.
The time to expiry for the options is one year. The volatility (standard
deviation) of EM’s shares is 25% and the company has decided not to pay
any dividends this year.
On the basis of these forecasts, you been asked to estimate the option
premiums for a strike price of £47.
Once the relevant premium has been estimated, your firm are planning to
promote and sell the financial products to all prospective clients and to use
this analysis as a tool for explaining share options to junior members of staff.
Required:
a) Using the Black-Scholes option pricing model, calculate the call premium
price for the shares of EM
State four limitations of the model.
Note: that d1and d2 should be estimated to two decimal places
(9 marks)
b) Calculate, using the call-put parity theory, the put premium at the strike
prices for the shares of EM.
(4 mark