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The following is an extract from the statement of financial position of Henleaze Co. Equity and reserves $ Ordinary share capital $0.50 shares 10,000,000 Reserves 35,000,000 Total equity and reserves 45,000,000 Non-current liabilities 8% preference shares 5,000,000 9% Loan notes 15,000,000 Bank loan 10,000,000 Total non-current liabilities 30,000,000 Total capital and non-current liabilities 75,000,000 The ordinary shares of Henleaze Co. are currently trading at $3.50 per share on an ex-dividend basis and have a nominal value of $0·50 per share. Ordinary dividends are expected to grow in the future by 3% per year and a dividend of $0·40 per share has just been paid. The 8% preference shares have an ex-dividend market value of $1.20 per share and a nominal value of $1·00 per share. These shares are irredeemable. The 9% loan notes are currently trading at $98.50 per loan note on an ex-interest basis and will be redeemed at $105 per loan note in five years’ time. The bank loan has a fixed interest rate of 5% per year. Henleaze Co. pays corporation tax at a rate of 25%. The directors of Henleaze Co. are looking to invest in a range of projects including one named ‘Steady’ and another called ‘Adventure’. Project ‘Steady’ is similar to the current activities of the company in its current markets and would require an investment of $5 million, whilst ‘Adventure’ is a project that would involve diversifying into a new industry which has a different market and would require an investment of $25 million. Required: Produce a report for the directors of Henleaze Co which includes the following: 1. A calculation of the market value weighted average cost of capital (WACC) for Henleaze Co. State clearly any assumptions that you make. 2. A calculation of financial gearing using book values and market values. 3. An explanation of the limitations of using the dividend valuation model to calculate the cost of equity used in the WACC, and a discussion of how the capital asset pricing model (CAPM) could be used to calculate a project-specific cost of capital that Henleaze could use to evaluate project ‘Adventure’. You should state the information requirements for calculating the CAPM. Your work should be word processed, clearly laid out and concise. Calculations should be performed on a spreadsheet


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