@ 2010Q1.Redeemable debtMarket value debt = 6.1m*1.065= 6,496,500Net interest = 9(1-0.3) = 9*0.7 = 6.3%Internal rate of return: YearCF5%PV110%PV20106.51106.51106.51-5-6.34.330-27.293.790-23.8775-1000.784-78.40.621-62.10.8120.523Internal rate of return= 5 + (. 81/. 81-20.523) * (10-5)= 5 + (-0.041)*5 = 4.795= 4.795% Irredeemable debtMarket value debt = 2.3m*. 84 = 1,932,000Cost of debt (Kd) = 6(1-0.3)/. 84 = 4.2/. 84 = 5% EquityPBIT = 6,320,000Interest (9% on 6.1m) = 549,000Interest (6% on 2.3m) = 138,000PBT = 5,633,000Tax 30% = 1,689,900PAT = 3,943,000Profit paid as dividends = 3,943,100*0.45 = 1,774,395No of shares = 6,600,000/250 = 2,640,000Dividend just paid = 1,744,395/2,640,000 = 0.6722 = 67.22pCost of Equity = 67.22 (1+0.0565)/842 + 0.0565 = 14.08%Market value of equity = 2.64*8.42 = 22,228,800Market value of equity and debt = 6,496,500+1,932,000+22,228,800 = 30,657,300WACCWACC = 14.08*(22,228,800/30,657,300) + 5.04*(1,932,000/30,657,300) + 4.795*(6,496,500/30,657,300)WACC = 10.209 + 0.318 + 1.016 = 11.543WACC = 11.5%The above calculations indicate that the Evans Plc is in a better position worthwhile to undertake its business adventure.
This is so because the calculations show the firms cost capital being in a position to venture into risk and competitive markets. Since the WACC of Evans Plc is 11.5 percent, 0.5 percent below the standard value, the company should engage in investments which will bring a higher rate of return which is more than 11.5 percent.
Q2.If Evans Plc needs to base its future developments through the use of dividend valuation model, the management of the company must understand what the model pertains in terms of its strengths and weaknesses (Kretlow, McGuigan and Moyer 2009). Dividend valuation model which is quite traditional though popular in company analysis is referred as dividend discount model (DDM). This valuation model is simply a mathematical approach used by businessmen or the stockbrokers which helps in pricing of the share of the company in respect to its dividend value (Eakins and Mishkin 2006).
This is an approach which is chiefly used by companies, for instance Evans Plc which wants to venture in new lines of business in valuing their stocks which are regarded as common by the company (Kretlow, McGuigan and Moyer 2009). Evans Plc, which is considering to venture in the game console as its new line of business, whose target market is the children’s toy, using the dividend valuation model alone will not be sufficient since the model does not put into consideration the cost of estimation of the market survey, it only deals with future gains (Eakins and Mishkin 2006).
This is so because the dividend valuation model, when used in the financial theory which the case for Evans Plc, will give the present value of all future cash flow that the company is deemed to receive (Kretlow, McGuigan and Moyer 2009). The result of using the dividend valuation model will be the intrinsic value of stock (value of all future dividends discounted at the appropriate discount rate), which does not cater for the market survey and the market plan development.
Evans Plc has already a WACC that is equivalent to 11.5 percent which is not fully enough to keep the company going. This method which makes valuation on common stock (the right to receive future dividends) is fully appropriate to be the only source of development for the company that has good reputation in its area of operation. This model has certain assumptions which the management of Evans Plc needs to be aware of before thinking of implementing it in its new adventure of game console (Eakins and Mishkin 2006).
One of the main assumption is that the dividend value is will only be known by the investors of Evans Plc and this will exclude other stakeholders. Distribution of the dividends of the company should be conducted on an annual basis and this should be conducted to infinity.