Principles of Finance

Assessment Information

This assignment is an individual assignment.

This assignment requires you to answer all questions

Criteria for Assessment

This assignment is designed to assess learning outcomes:

Introduction to capital markets and investment process
Capital appraisal techniques
Diversification and optimal portfolio allocation of risky assets
Capital asset pricing model and the security market line

Word Count
The word count is 1,500 words

There will be a penalty of a deduction of 10% of the mark (after internal moderation) for work exceeding the word limit by 10% or more.
The word limit includes quotations and citations, but excludes the references list.

Setting:

It is June 1st 2022. BST Plc has established itself as one of the leading retail banks in the UK. The firm’s debt is currently rated at B+, however the company has been performing very well and expect a significant upgrade to AA status shortly. In light of its recent success, the firm is considering increasing the number of branches it has.

BST Plc Capital Structure:

BST Plc has 400m shares in issue which currently trade at £2.65 each. Its only debt is in the form of 15m bonds that have exactly 6 years left to expiry, these have a coupon rate of 8% and face value per bond of £100.

The Branch Expansion Project:

The company hopes to open small bank branches in small towns and village around the UK. The aim is to open 50 new banks across the UK, although this number is very dependent on the availability of suitable premises.

The company has carried out a feasibility study, the cost of which was £24 million which is due for payment in one year. Based on this, BST estimates the cash flows – per new bank branch – will be:

Year 3 cash flows per outlet
Revenues £61m
Banking Costs £30m
Staff Costs £15m
Insurance Costs £5m
Tax £6.1m

The viability study also concluded the following:

The project will require the following cash injections (these exclude fees due to Dalglish Inc.) o An immediate investment of £800m o A further investment of £100m at the end of Year 1 o A further £900m at the end of Year 2

Other than the cash injections above there will be no other cash flows in Years 1 or 2

From Year 3 until Year 6:
o Revenues will grow at 12% per year o Banking Costs will increase by 15% per year o Staff Costs will increase by 10% per year o Insurance costs will increase by £1.5m per year (per outlet) o Tax costs are expected to remain at 10% of total revenues

Cash flows in Year 7 and every year thereafter will be identical to those in Year 6.

Funding:

With regard to the £900m payable at the end of Year 2, the firm intends to invest £800m in a portfolio consisting of 25% of Stock A and 75% of Stock B at the end of Year 1. Details of the expected returns for each stock in Year 2 are shown below:

UK Economic Growth Probability Returns Stock A Returns Stock B
High 0.2 12% 36%
Average 0.7 14% 12%
Low 0.1 30% -20%

Required:

Using the information provided in the case above, write a report for the board of directors of BST Bank Plc providing an analysis of the proposed project and recommendations for the company.

Specifically the final report should include:

An estimate of the current Weighted Average Cost of Capital (WACC) of the company.
A detailed cash flow forecast for the whole project (50 banks).
An appraisal of the project using any techniques you think are appropriate.
An estimate of how much the portfolio is expected to be worth at the end of Year 2 and whether the firm will need any additional capital to fund the project.
A final recommendation of whether the project should be accepted.