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is swapped, there will be no change in the interest charge to earnings for the six year debt from the
current 5.5% per annum unless the lender has the ability to vary the variable rate on current
borrowing for any further changes in credit rating. Because the fixed and floating rates are same at

6.2% (given that the current credit spread is 70 basis points over US$ LIBOR, or in addition to the
swap rate of 5.5%), the nominal value of our debt will remain equal to its current market value,
therefore the reduction in basis points will reduce the effective coupon and the yield to 5.9%.

4.3.3 Cost of finance (WACC)
Appendix 5.4 shows our cost of equity right now is 12% and our WACC is 7%. Unbundling the
property portfolio required we de-gear our current beta of 1.824 and then use the result to determine

our equity beta inclusive of the property portfolio and then use that to estimate our new WACC if the
unbundling goes ahead. Option 1 shows our WACC will rise to 9% whilst Option 2 will drop it to 4%.
The Modigliani and Miller theory of capital structure supports this shift –it requires that the firm/option
with the higher gearing should have the lower WACC. However, this theory presumes that debt is

risk free which is not the case here as the recent credit downgrade has increased our beta from 0 to
4. Perhaps the U-shaped traditional theory of capital structure offers a better explanation –probably,
Option 2 with higher gearing and lower WACC will lie to right and towards the optimal capital

structure compared to Option 1; there is however one caveat to this conclusion!

4.3.4 Valuation

It is tough to predict with precision the likely impact of an unbundling exercise such as this on our
value –we have assumed in the WACC calculations (Appendix 5.4) that the share price/value will
remain the same in each scenario –quite unrealistic in practice as we know gearing impacts value
and vice versa. A valuation model will need to be constructed to assess the full impact of either

option but given the recursive nature of the problem in that the output value determines the
estimation of the equity beta, which is also an input variable in the calculation, computer modelling
will be required.

In Summary
Right Now! OPTION 1 OPTION 2 CONCLUSION
De-lever balance sheet Repurchase shares
Impact on EPS - 14 cents 20 cents Option 2 is better
Impact on gearing (D/D+E) 59% 46% 76% Option 1 is better
Impact on WACC 7% 9% 4% Option 2 is better
Impact on share value N/a Inconclusive Inconclusive Inconclusive

4.3.5 Other considerations
Whilst we know which debt holders will be repaid in Option 1, it is uncertain in Option 2 which

shareholders will sell shares, if at all. The PIC’s 15% holding represents 463 million shares (15%*
US$772 million / US$ 0.25 per share). The full US$ 6400 million received from the unbundling can

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