Extractoil Plc is an oil and gas business that is registered as a company in England and listed on the London Stock Exchange. It has the majority of its operations in Central and South America. The company has rights to explore for offshore oil and gas reserves in that part of the world that it has not previously sought to exploit.
Extractoil Plc now wishes to expand its operations and use its previously unused exploration rights. In order to finance these new operations it intends to make an issue of ordinary shares. The business is currently financed only by a combination of ordinary share capital and loan capital.
The company’s ordinary shares have a nominal value of £ 0.65 and a current market value of £67.31. The current level of dividend is £0.61 per share and this has been growing at a compound rate of 8.9% a year in recent years.1. On the basis of the information you have been provided, calculate the weighted average cost of capital (‘WACC’) that should be used in future investment decisions by Extractoil. [10 marks]……
Marks will be awarded for both the final result of calculations and the workings that show how you arrived at your answers. Please round your figures to the nearest £1,000.
The information you have been give above will enable you to use the dividend valuation model to calculate the cost of ordinary shares. There is an alternative method that you could have used if you had been provided with the necessary information.
2. What alternative method could you have used to work out the cost of ordinary shares to Extractoil Plc? You are not required to calculate the cost of ordinary share capital using this method.
Assuming that the required return for shareholders in Extractoil Plc is already known then what additional information would you have needed in order to use this alternative method instead? [10 marks]
3. Please discuss the merits of the alternative method as a means of assessing the cost of ordinary shares. As part of your discussion, you should comment on the sources of the additional information you would need to locate in order to employ the model. [15 marks]
4. Comment on the remarks made by both Investex and Oiltech. [15 marks]
Please explain any assumptions you make in giving your answers to the questions in Part A. You should comment on the information provided to you for this question where appropriate.