Question

 

CSL Ltd is considering issuing additional ordinary shares to raise capital for developing and manufacturing a Covid-19 vaccine. The company is expected to pay a dividend of $0.50/share at the end of year 4 and dividends will grow at a constant rate of 3% per annum forever. CSL Ltd has a beta of 1.5. Long-term treasury bonds are yielding 4% per annum and the long-term return of the ASX200 (i.e. the market portfolio) is 10% per annum.

a) Using the Capital Asset Pricing Model, calculate the expected rate of return of CSL Ltd. (3 marks)

b) What is the implied value of one of the issued ordinary shares? (6 marks)

c) If CSL Ltd intends to sell the ordinary shares at $4/share, would you purchase it? Briefly explain why? (2 marks)

d) CSL Ltd is also considering to issue some preference shares for those risk-averse investors. Briefly explain why ordinary shares are riskier than preference shares. (4 marks)

Answer 1

A-	expected rate of return	risk free rate+(market return-risk free rate)*beta	4+(10-4)*1.5	13
B-	Terminal value of stock at end of year 4	expected dividend/(required rate of return-growth rate)	.52/(14%-4%)	5.2
	expected dividend in year 5	dividend in year 4+(1+growth rate)	.5*(1.04)	0.52
	growth rate			4%
	required rate of return			13%
	Present value of stock	(dividend in year 4 + terminal value at year 4)/(1+required rate of return)^n	(.5+5.2)/(1.13)^4	3.50
C-	if CSL would sell it at a price of 4 then we would not purchase It as its intrinsic value is 3.5 which is less than the issue and this stock seems overvalued.
D-	preference shares carries preferntial rights of payment of dividend and repayment of capital before any payment made to equity stock holders thus it can be said that preference shares are more secured in comparison to equity stock and it is hybrid form of financing which carries features of debt like dividend at fixed rate and features of equity like ownership in the company.