IT Solutions Plc. is listed on the London Stock Exchange. It operates in two distinct sectors, its
IT Infrastructure Division (IID) develops hardware and software systems for public sector
clients and its Consumer Division (CD) develops hardware and software products for
consumers. It is considering bidding for a contract to develop a new health information system
for the UK Government. However, initial analysis indicates that the IRR of this project would
be below the company’s WACC. The Managing Director of the IID argues that this WACC is
not appropriate for projects in her Division as they are less risky, on average, than the firm as
a whole. The CEO of IT Solutions is unconvinced and argues that the Managing Director is
trying to make the project appear more attractive than it actually is.
The IID and the CD account for approximately 35% and 65% of company profits respectively.
Estimates of IT Solutions’s beta are 1.4 (estimated over 60 days), 1.1 (estimated over 2 year)
and 1.5 (estimated over 60 months). IT Solutions has a target Debt to Value ratio of 0.6/1.
Estimates of the Equity Risk Premium are 7.0% (estimated over 1 year), 6% (estimated over
10 years) and 5.50% (estimated over 75 years). The marginal corporation tax rate is 35%.
UC’s debt comprises traded bonds, with a par value of £1,000 and 10 years remaining to
maturity, which pay a semi-annual coupon (annual coupon of 6%) and are trading at £1,065
today.
The following information is also available to you.
UK Listed Companies in the IT sector.
Company Beta Debt/Value % of Profit Generated in Consumer IT sector
Compu A 1.1 0.3 91%
Compu B 1.7 0.5 55%
Compu C 0.9 0.2 93%
Government Bond Yields
1 Year 2 Year 5 Year 30 Year
Yield to Maturity 0.50% 0.75% 1.20% 1.80%
Required:
(i) Estimate a Weighted Average Cost of Capital appropriate for the analysis being
conducted by the IT Infrastructure Division. Briefly explain and comment on each
choice you make about which inputs you use.
(25 Marks)
(ii) Critically assess the arguments of the CEO and the Managing Director in relation to the
appropriate discount rate for this project.
IT Infrastructure Division (IID) develops hardware and software systems for public sector
clients and its Consumer Division (CD) develops hardware and software products for
consumers. It is considering bidding for a contract to develop a new health information system
for the UK Government. However, initial analysis indicates that the IRR of this project would
be below the company’s WACC. The Managing Director of the IID argues that this WACC is
not appropriate for projects in her Division as they are less risky, on average, than the firm as
a whole. The CEO of IT Solutions is unconvinced and argues that the Managing Director is
trying to make the project appear more attractive than it actually is.
The IID and the CD account for approximately 35% and 65% of company profits respectively.
Estimates of IT Solutions’s beta are 1.4 (estimated over 60 days), 1.1 (estimated over 2 year)
and 1.5 (estimated over 60 months). IT Solutions has a target Debt to Value ratio of 0.6/1.
Estimates of the Equity Risk Premium are 7.0% (estimated over 1 year), 6% (estimated over
10 years) and 5.50% (estimated over 75 years). The marginal corporation tax rate is 35%.
UC’s debt comprises traded bonds, with a par value of £1,000 and 10 years remaining to
maturity, which pay a semi-annual coupon (annual coupon of 6%) and are trading at £1,065
today.
The following information is also available to you.
UK Listed Companies in the IT sector.
Company Beta Debt/Value % of Profit Generated in Consumer IT sector
Compu A 1.1 0.3 91%
Compu B 1.7 0.5 55%
Compu C 0.9 0.2 93%
Government Bond Yields
1 Year 2 Year 5 Year 30 Year
Yield to Maturity 0.50% 0.75% 1.20% 1.80%
Required:
(i) Estimate a Weighted Average Cost of Capital appropriate for the analysis being
conducted by the IT Infrastructure Division. Briefly explain and comment on each
choice you make about which inputs you use.
(25 Marks)
(ii) Critically assess the arguments of the CEO and the Managing Director in relation to the
appropriate discount rate for this project.
