solution

Bristol plc has convertible with a coupon rate of 10% in issue trading at £108%. The debentures are redeemably at par in five years time, or convertible at that point into 20 ordinary shares of the firm. The company’s current share price is £3.50 pounds and is expected to grow at 6% p.a. Bristol plc faces a corporation tax rate of 20%. Which of the following is the best estimate of the after-tax cost of these debentures? Tourcay plc exist in a Modigliani and Miller (1958, 1963) world, except that corporate taxes exist at a rate of 30%. The cost of capital for an all-equity finance firm in this world is 18% p.a., and the pre-tax market cost of debt is 9% p.a. Tourcay plc is funded by way of £90 million equality an £50 million debt (both at market values). What is Tourqay plc’s cost of equity capital? UHG plc runs a hotel chain. Assume that it’s now UHG plc’s financial year and 31 March 2022. The firm is considering a three-year project to build and operate rapid Covid-19 screening facilities next to the hotels, with a view to improving sales for the hotel. The company hired a consultant, at a cost of £100,000 (paid in full last month), to assess the likely impact of these facilities on the hotels’ income. The findings by the consultant suggest that the most likely impact would be an increase in sales of £200 million p.a. (70% probability). But the consultant also suggests that, dependent on the pandemic situation, the increase in sales for each of the three years could be as high as £300 million (10% probability) or as low as £50 million (20% probability). UHG plc generates a contribution of 40% on sales. This project will also lead to an incremental fixed cost of £30 million p.a., and an allocated head office fixed costs £10 million p.a. The facilities will be built in a part of the company’s premises which is currently rented out to a travel agent at an annual rent (taxable) of £2 million, received in advance. The project also requires an investment of £100 million in equipment on 31 March 2022. The equipment attracts a 20% (reducing balance) capital allowance and will be disposed of for £20 million after three years of use. An investment in working capital of £500,000 will be required on 31 March 2022. This requirement will remain constant each year throughout the 3-year life of the project. Working capital will be fully recoverable on 31 March 2025. Corporation tax is payable at the rate of 25% and tax payment occurs in the same years as the cash flows to which it relates. An appropriate cost of capital to appraise the project is 12% p.a.

a) Calculate the NPV of the Covid 19 screening facilities project as a 31 March 2022 and advise the company whether it should proceed with the project.

b) Calculate the sensitivity of the NPV to changes in the expected extra contribution.