mock 2007 q 3

[mtm]

Hi

I have done mock exam 2007 and am hoping that the forum members could shed some light on some of my problems. I would really appreciate a reply within the next few days. :0)

(i)In the solutions at the bottom of pg 14, the "value of the company" is taken as 12x£30=£360m. I presume that this is a misprint or it is implicitly implied that this is the value of the shareholders part of the company. V=D+E and hence the value of the share cap here is just the “E” part.

(iii) In the solution here £360 (MV of equity) is added to £180 (nominal value of debt) plus cash of £20m to get £560. Surely add like with like, why does the solution add market value of equity with nominal value of debt? Is the solution assuming that nominal value of debt = market value of debt?

The solution then goes on to assume that the gearing required of 25% refers to D/V, yet in the solution of (i) gearing refers to just D/E. Surely this is inconsistent?

If I assume that the analysis is correct so far then from the second last paragraph the Private Equity group owns £60m of the firm and the directors own £360m of the firm. The directors own 86% of the firm and they are happy because this is greater than the min of 75% that they required. Yet the last paragraph does something very different to obtain £126m. It is inconsistent with the paragraph above because in the paragraph above the directors hold 86% of the firm but in the paragraph below the PE group suddenly hold 25%, i.e. the directors hold exactly 75% of the firm. The restructuring here sounds rather complicated. I was wondering if it could not simply be:

The PE group injects £60m into the firm. This pays off debt of £40m and leaves cash of £20m. The PE group then gets £60m worth of shares issued to it.

Thanks!

 

[Colin McKee]

mock 2007

Hi
I dont quite see your comment on the £360 being a misprint. the company made £30 earnings in the previous year; the solution suggests a PE ratio of 12, therefore a valuation of the shares is about 12 * 30 = 360m. You will need to explain your concern a bit here.
The debt is valued at nominal. This is an OK assumption as debt market values usually trade around nominal. It is better to use market value for equity as equity market values can be a multiple of 5 or 10 times par value, and therefore the solution uses market value here.
I will amend the question to say that the company should be structured 25% with debt, rather than 25% gearing. There are two definitions of gearing: D/E and D/D+E (which is the D/Value of assets you refer to). I have used the latter.
the analysis of the restructuring looks OK to me. the £200m injected by the PE company should give them £140 debt and as high a proportion of the new equity shares as they can negotiate. In that the question says that the directors want 70% of the equity shares, I have assumed that the PE company are happy to take 30% of the new restructured company. You seem to suggest that, because the directors holdings of the old company shares has a value of 360m, that they deserve 360/420 of the new company. the reality is that the PE company would grab as much as they can get. If the directors have said they want 70% then the PE company will take 30%. Hence they get a profit at the directors expense.