Muhammad Afif

ANSWER NUMBER 9
a. Given:
Cash dividend for 20
0p
years =

(In pence)
Share Price
Present time Share index
(pence)
0 580.00 3,100.00
Share Price
Time before present Share index
(pence)
1 560.00 3,000.00
2 550.00 2,400.00
3 600.00 2,500.00
4 500.00 2,000.00
5 450.00 1,850.00
6 400.00 1,700.00
7 250.00 1,300.00
8 170.00 1,500.00
9 130.00 1,300.00
10 125.00 1,000.00

1) Historical Share Price over 3 years ago

Time until present CF (pence)
3 (600.00)
2 0.00
1 0.00
0 580.00
IRR -1.12%
TSR (3 years ago) -3.33%

2) Historical Share Price over 5 years ago

Time until present CF (pence)
5 (450.00)
4 0.00
3 0.00
2 0.00
1 0.00
0 580.00
IRR 5.21%
TSR (5 years ago) 28.89%

3) Historical Share Price over 10 years ago

Time until present CF (pence)
10 (125.00)
9 0.00
8 0.00
7 0.00
6 0.00
5 0.00
4 0.00
3 0.00
2 0.00
1 0.00
0 580.00
IRR 16.59%
TSR (10 years ago) 364.00%

b. The problems of TSR as a metric for judging managerial performance:

1) Vulnerable to distortion by the selection of time period over which it is measured;
2) Need to express the TSR relative to a peer group to obtain impression of performance;
3) It fails to relate risk to the TSR;
4) Assumes stock market perfection in share pricing;
5) Useless for firms without a quotation;
6) Limited to past performance, no sense of future returns;
7) Effective only for investments with cash inflows;
8) Sensitive to stock market sentiment; and
9) Doesn't reflect size of investment.

c. Given:
Required rate of return (k) = 9.00% per year (for 5 years and 10 years)
 Muhammad Afif

Outstanding shares = 10,000,000 shares

Rate of return for 5 years 53.86%

Rate of return for 10 years 136.74%

Market Cap 5 years ago = 4,500,000,000.00 p £ 45,000,000.00

Market Cap. (ending) = 5,600,000,000.00 p _ OR £ 56,000,000.00 _
Change in Market Cap
over 5 years 1,100,000,000.00 p £ 11,000,000.00

WAI over 5 years = Change in Market Cap. for 5 years - Return for 5 years
WAI over 5 years = £ 11,000,000.00 - £ 24,238,077.97
WAI over 5 years = (£13,238,077.97)

Market Cap 10 years ago = 1,250,000,000.00 p £ 12,500,000.00

Market Cap. (ending) = 5,600,000,000.00 p _ OR £ 56,000,000.00 _
Change in Market Cap
over 10 years 4,350,000,000.00 p £ 43,500,000.00

WAI over 10 years = Change in Market Cap. for 10 years - Return for 10 years
WAI over 10 years = £ 43,500,000.00 - £ 17,092,045.93
WAI over 10 years = £26,407,954.07

d. The advantage of WAI over TSR:

- Relates return to risk class by allowing for opportunity cost of capital.

The difficulties of using WAI:

1) There are doubts about the CAPM as a method of calculating the required rate of return;
2) The assumption of stock market pricing perfection can be challenged;
3) In bear markets most companies show negative WAI for years, despite the management performing well against their sector or the market;
4) Useless for firms without a quotation; and
5) Affected by relative size of firms – favours large firms

ANSWER NUMBER 10
Given:
BV of Sity plc Capital = £ 15.00 m 25 years ago
MV of Sity plc shares = £ 90.00 m
MV of Sity plc debt = £ 20.00 m
BV of Sity plc debt = £ 20.00 m

a. Sity plc MVA = MV of Sity plc shares - Capital

Sity plc MVA = £ 110.00 - £ 15.00
Sity plc MVA = £ 95.00 m OR £ 95,000,000.00

b. Sity plc MBR = MV of Sity plc shares ÷ Capital

Sity plc MBR = £ 90.00 ÷ £ 15.00
Sity plc MBR = 6.00

c. Given:
5 years ago
BV of Pity plc Capital = £ 15.00 m
MV of Pity plc shares = £ 90.00 m
MV of Pity plc debt = £ 20.00 m

Pity plc MVA = MV of Pity plc shares - Capital

Pity plc MVA = £ 110.00 - £ 15.00
Pity plc MVA = £ 95.00 m OR £ 95,000,000.00

Pity plc MBR = MV of Pity plc shares ÷ Capital

Pity plc MBR = £ 90.00 ÷ £ 15.00
Pity plc MBR = 6.00

- The two firms has the same MVA and MBR

- The problems of using MVA and MBR for inter-firm comparison:
1) Size of business not allowed for in inter-firm comparisons;
2) The difference in the year of invested capital between the two firm is not taken into account. Inflation can distort MVA and MBR;
3) Two firms with the same MVA may have generated different levels of wealth for shareholders because the MVA fails to allow properly for dividends p

d. Given:
Sity plc Required rate of return = 8.00% per year
Pity plc Required rate of return = 10.00% per year
 Muhammad Afif

- Sity plc Dividend History: - Pity plc Dividend History:

(In £ millions) (In £ millions)
Times before
Dividend FV Times before present Dividend FV
present
1 0.00 0.00 1 2.00 2.20
2 0.00 0.00 2 2.00 2.42
3 3.00 3.78 3 2.00 2.66
4 0.00 0.00 4 2.00 2.93
5 2.00 2.94 5 2.00 3.22
Total 5.00 6.72 Total 10.00 13.43

Sity plc Actual Wealth = £ 96.72 m

Sity plc Expected Wealth = £ 22.04 m _
Sity plc ER = £ 74.68 m OR
Sity plc ER = £ 74,677,871.00

Pity plc Actual Wealth = £ 103.43 m

Pity plc Expected Wealth = £ 24.16 m _
Pity plc ER = £ 79.27 m OR
Pity plc ER = £ 79,273,570.00

e. The advantages of using MVA:

1) Assesses wealth generated over entire business life;
2) Managers judged on the MVA have less incentive to invest in negative NPV projects than those judged on earnings growth; and
3) Measures in absolute amounts of money.
The disadvantages of using MVA:
1) Many doubts about the validity of the capital invested figure used
2) Excessive faith in the correct pricing of shares by stock markets
3) Size of business not allowed for in inter-firm comparisons
4) Do not know in which part of the firm’s history the value was created
5) Inflation can distort the MVA
6) Do not know if rate of return obtained is higher or lower than the required rate or return given the opportunity cost of capital
7) Two firms with the same MVA may have generated different levels of wealth for shareholders because the MVA fails to allow properly for dividends p

The advantages of using ER:

1) Allows for the time value of money on shareholder funds put into the business
2) Gives credit for dividends received by shareholders
3) Assesses wealth generated over the entire life of the firm
4) Managers judged on an ER have less incentive to invest in negative NPV projects than those judged on earnings growth
5) Measures in absolute amounts of money.
The disadvantages of using ER:
1) Size of business not allowed for in inter-firm comparisons. Larger companies tend to produce the better ERs
2) Excessive faith in the correct pricing of shares by stock markets
3) There is difficulty in selecting the appropriate required rate of return, especially if inflation has varied considerably
4) Useless for firms without a quotation for their shares
 Muhammad Afif

st their sector or the market;

MVA and MBR;

A fails to allow properly for dividends paid in previous years;
 Muhammad Afif

ings growth; and

A fails to allow properly for dividends paid in previous years;