Calculate CAPM and WACC For AeroBeing's Assignment

Assignment Task

Question 1

1. Briefly describe the Capital Asset Pricing Model (CAPM) and explain the meaning of the beta (β) coefficient.
2. AeroBeing is a large company with two departments: aerospace and air transport. Each department currently finances its activities through 45% of debt finance, 35% of ordinary equity, and 20% of preferred equity.

The cost of preferred equity is equal to 11%. The company’s borrowing rate is 10%, while its tax rate is 35%.

AeroBeing’s management would like to know the minimum weighted average cost of capital for each department. Since the beta for the two departments cannot be computed, the management identified two companies that operate in the same sectors and have a capital structure similar to AeroBeing, thus providing good proxies for the required beta values.

The first company is a key operator in the aerospace sector and has a beta of 1.5, while the second company is a growing player in the air transport sector that has a beta of 0.5. The risk-free rate is currently 9% and the expected market return is 15%.

• i. Compute the weighted average cost of capital for each department of AeroBeing.
• ii. Compare the two figures found in part b(i). How would AeroBeing use this information?

Question 2

Blue Storage Ltd is considering a major investment to increase the number of square meters of storage space it can offer their customers. The investment is in light of some market research (cost £15,000), which has already been carried out amongst their customer base to consider how the level of demand is going to increase in the next four years.

Blue Storage Ltd has two options available. The first option involves increasing the level of storage at its current storage depot by 25%. The second option involves moving all their operations to a new unit 25 miles away, which will result in their storage space increasing by 50%.

The company uses the straight-line method of depreciation and has a cost of capital of 12%. It is assumed the residual value of Project A will be £100,000 at the end of the 4 years, while for Project B it will be £150,000. These residual values are not included in the cash flow projections given below.

Net Cash Flows (£)

1. Calculate the payback period of both projects in years and months.
2. Calculate the net present value (NPV) of both projects. The figures should be rounded to the nearest £. 
3. Calculate the accounting rate of return (ARR) of both projects. The figures should be rounded to two decimal points.
4. Based on the results from calculations in parts (a), (b) and (c), which project should Blue Storage Ltd invest in? Explain your answer.
5. Parts (a) to (d) have focused on the financial elements of the decision-making. Explain in your own words the non-financial elements that could contribute to the decision on which project (if any) to go ahead with.

Question 3

a. According to the latest annual report, Getafix Plc has total assets of £1.2 billion and total liabilities of £400 million. The company has 100 million shares outstanding.

• i.Determine the net asset value (NAV) per share of Getafix Plc. (4 marks)
• ii. Considering that the company's stock price is currently £9.50, does the NAV method indicate that it would be a good purchase? (2 marks)

b. The dividend payout ratio of Getafix is 24%, its cost of equity (RE) is equal to 12% and its expected perpetual growth rate (g) is 4%.

• i.What is the theoretical price-to-earnings (P/E) ratio on the basis of a model constructed using Gordon's growth formula? (4 marks)
• ii.If Getafix Plc's actual prospective PE ratio is 3.6, would you recommend that investors buy the company's shares?

c. You have decided to compare relative valuation ratios for Getafix Plc with the average ratios within the industry. The table below summarises your findings. Based on the assumption that Getafix Plc’s risk levels and growth prospects are comparable with those of other companies in the industry, would you recommend investing in this company based on the statistics presented in the table? Explain your answer. 

Question 4

You must answer all parts of this question.

Imagine that you want to use the discounted cash flow valuation method to find the fundamental value of BO2 Plc. You have managed to generate a projection of the free cash flow to the firm (FCFF) for the company for the next 5 years:

Following this prediction period, you anticipate that the cash flow will continue to grow perpetually at a rate of 4% per annum. The weighted average cost of capital (WACC) is 7%. Assume that the company will never go bankrupt.

a. Using the WACC rate, calculate the present value of the free cash flows to the firm to 2 decimal points over the next five years.

b. Compute the terminal value of BO2 Plc and discount it back to express it in present value terms (again to two decimal places).

c. Calculate the value of BO2 Plc. Figures should be rounded to two decimal places.

d. Calculate the fundamental stock value if the market value of debt is £85 million and the number of outstanding shares is 10 million. Round the figures to two decimal places.

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