Question 1 Suppose you are a senior portfolio manager of an international investment bank that oversees a US investment portfolio with total assets of £28 billion

Subject:BusinessPrice: Bought3

Share With

Question 1

Suppose you are a senior portfolio manager of an international investment

bank that oversees a US investment portfolio with total assets of £28 billion.

For company B&G Ltd., you know the following information:

 

EBIT= £840,000

Interest rate = 7% (before tax)

Expected market return (Rm) = 8%

Total debt = £1.5 million

Tax rate= 35% β of B&G

= 1.4

Total equity = £4.5 million

Risk free rate (Rf) = 5%

 

a) What do you think about the current capital structure of this company? Is

this company creating value?

 

b) The CFO suggests buying back shares (at their book value) and thus

reducing the equity capital to £2.5 million (again, at book value).

They will use cash for the buyback and everything else ceteris paribus. Is

this a good suggestion? Critically evaluate your answer.