Question 3
ICAN
•
2025
•
STRATEGIC FINANCIAL MANAGEMENT
•
mixed
Case Stimulus
Zeco Plc (ZP) is a listed company in the residential building construction industry. Over the past five years results have been disappointing and consequently the share price has fallen from a high of 3.50 per share five years ago to only 1.05 per share today. This deterioration in performance and share price have been accompanied by an increase in financial gearing to a high level. Zeco Plc capital structure is as follows: ’m Equity: Share capital (0.50 per share nominal value) 40 Retained earnings 35 Long – term liabilities: 6.5% irredeemable loan notes (100 per loan note nominal value) 250 7% bank loan 20 Zeco Plc. loan notes are quoted at 65 per loan note and both the loan notes and the bank loan are secured. Zeco Plc equity beta is 2.3. New venture To improve performance, Zeco Plc. is considering the construction of commercial properties such as office blocks and industrial complexes. This is a new activity for Zeco Plc and it is expected that the risks involved will be different from its current activity. The Finance Director has proposed that a project-specific discount rate should be used to appraise the new venture, but the Commercial Director does not believe this is necessary.
Requirements
(
a
)
i. Using the Capital Asset Pricing Model, calculate Zeco Plc current cost of equity and a project-specific cost of equity suitable for the new venture.
(
ii
)
Referring to your calculations above, comment briefly on the view of the Commercial Director.
(
b
)
Discuss three problems Zeco Plc may be facing as a result of its current high level of gearing.
(
c
)
In respect of both equity and debt, discuss the risk-return relationship and how it affects Zeco Plc. financing costs.
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About This Question
This is
Ican
2025
Strategic Financial Management
Question 3.
It is one of the
mixed
questions from the
2025
Ican
Strategic Financial Management
examination.