Revision Course Notes [Revision 6]
ACCA F9
Financial Management
Revision Class 4
Session 4
Patrick Lui
Revision 6
Revision 6 – Business Valuations
Topic List
1. / Reasons for Valuations and Information Requirements / Exam Question Referencea. Reasons for valuation
b. Information requirements
2. / Models for Valuation of Shares
a. Assets-based valuations
l Net book value (balance sheet basis) / Dec 10
Dec 11 / Q4a(ii)
Q3a(i)
l Net realizable value / Dec 12
Pilot 14 / Q4a(ii),b
Q2a
l Net replacement cost basis
b. Income-based valuations
l Price/earnings ratio method / Dec 07
Jun 08
Dec 08
Jun 09
Jun 12
Dec 12
Pilot 14 / Q1a(i)
Q2c
Q1b
Q1b(i)
Q4a
Q4a(iii),b
Q2a
l Earnings yield method / Dec11 / Q3a(iii)
c. Cash-flow based valuation
l Dividend valuation model / Dec 07
Jun 08
Dec 08
Jun 09
Jun 10
Dec 10
Dec 11
Jun 12
Dec 12
Jun 13
Jun 14
Pilot 14 / Q1a(ii)
Q2a
Q1d
Q1b(ii)
Q4b
Q4a(i)
Q3a(ii)
Q4b
Q4a(iv),b
Q4a
Q4b
Q5a
l Discounted cash flow basis
3. / Valuation of Debt and Other Financial Assets
a. Irredeemable debt
b. Redeemable debt / Dec 12 / Q4c(i)
c. Convertible debt / Dec 07 / Q1b
d. Preference shares
4. / Efficient Market Hypothesis (EMH)
a. Weak-form / Dec 07
Dec 10 / Q1c
Q2c
b. Semi-strong form / Dec 07
Jun 08
Dec 10 / Q1c
Q2d
Q2c
c. Strong form / Dec 07
Dec 10 / Q1c
Q2c
5. / Implications of EMH for the Financial Manager / Dec 07 / 1c
6. / Practical Consideration in the Valuation
Chapter 17 Business Valuation
I. Shares Valuation
1. Which of the following best describes the replacement value of a business?
A Value if sold off piece-meal
B Value to replace assets with new
C Cost of setting up an equivalent venture
D Net present value of current operations
2. The following is a summary of ABC Co’s statement of financial position:
$mNon-current assets / 5
Net current assets / 3
8
Financed by:
$1 Ordinary shares / 1
Reserves / 5
Loan notes / 2
8
Non-current assets include machinery which cost $10 million which was purchased 7 years ago and has a useful life of 10 years. Monkton Co uses straight-line depreciation. These assets were recently professionally valued at $1 million.
What is the value per share using the realisable value basis of valuation?
A $1
B $2
C $4
D $6
3. Coombeshead plc has ordinary shares in issue that pay a constant dividend per share of 25p and have a beta of 1·2. The current market rate of return is 8% and the risk-free rate of return is 2%.
What is the predicted market value of each share of the company (to the nearest pence)?
A 179 cents
B 216 cents
C 272 cents
D 347 cents
4. SKV Co has paid the following dividends per share in recent years:
2013 / 2012 / 2011 / 2010Dividend (cents per share) / 36.0 / 33.8 / 32.8 / 31.1
The dividend for 2013 has just paid and SKV Co has a cost of equity of 12%.
Using the geometric average historical dividend growth rate and the dividend growth model, what is the market price of SKV Co shares to the nearest cent on an ex dividend basis?
A $4·67
B $5·14
C $5·40
D $6·97
(ACCA F9 Financial Management Pilot Paper 2014)
5. Thomworthy plc, which is financed entirely by equity, earns a constant return of 10% on its investments. The company has a constant dividend payout ratio of 40% and the earnings per share of the company is expected to be 50 cents at the end of the forthcoming year.
What is the predicted market value of each share of the company?
A 200 cents
B 206 cents
C 333 cents
D 500 cents
6. Plessur Co pays a constant dividend of $0·10 per equity share and these shares have a beta of 1·4. The current market rate of return is 9% and the risk-free rate of return is 3%.
What is the predicted market value of each equity share?
A $0·64
B $0·88
C $1·14
D $1·19
7. Bernina Co has recently paid a dividend of $0·30 per equity share. The company has a constant dividend payout ratio of 25% and achieves a 12% return on all new investments.
What is the predicted market value of an equity share?
A $1·30
B $2·73
C $3·43
D $10·90
8. Gannet Ltd is a private company that has ordinary shares in issue with a par value of £0·50 each. The company has recently paid a dividend of £0·15 per share. Tern plc is listed on the London Stock Exchange and operates in the same industry as Gannet Ltd. Tern plc has ordinary shares in issue with a par value of £1·00 and a current market value of £3·00. The company has recently paid a dividend of £0·27 per share. The rate of income tax on dividends is 10%.
Which one of the following is the value of each ordinary share in Gannet Ltd on a dividend yield basis?
A £0·56
B £1·50
C £1·67
D £1·85
9. Quartz plc pays an annual dividend of 30 cents per share to shareholders, which is expected to continue in perpetuity. The average rate of return for the market is 9% and the company has a beta coefficient of 1·5. The risk-free rate of return is 4%.
What is the expected rate of return for the shareholders of the company and the predicted value of the shares in the company?
Expected rate of return (%) / Predicted value (cents)A / 23.5 / 705
B / 17.5 / 171
C / 16.5 / 182
D / 11.5 / 261
10. Opal Ltd has 2 million $0·50 ordinary shares in issue. The company achieved the following results for the year that has just ended:
Operating profit / 440
Interest payable / 120
320
Corporation tax / 80
240
Dividend payable / 100
140
Kyanite plc, which operates within the same industry as Opal Ltd, has $1·00 ordinary shares in issue that have a current market price of $9·00. It has recently announced a dividend per share of $0·30. Kyanite plc maintains a constant dividend payout ratio of 40%.
What is the value of each ordinary share of Opal Ltd on the basis of Kyanite plc’s price/earnings ratio?
A $0·84
B $1·44
C $1·92
D $9·00
11. Arcturus plc has agreed to acquire all the ordinary shares in Mira plc and has also agreed a share-for-share exchange as the form of consideration. The following information is available:
$m / $m
Operating profit / 100 / 20
Net profit before taxation / 80 / 14
Net profit after taxation / 60 / 10
Share capital – $0.50 ordinary shares / $20m / $5m
Price/earnings ratio / 10 / 12
The agreed share price for Mira plc will result in its shareholders receiving a premium of 25% on the current share price.
How many new shares must Arcturus plc issue to purchase the shares in Mira plc?
A 8·0 million
B 10·0 million
C 10·5 million
D 12·0 million
12. Kajan plc has recently issued a dividend of $0·20 per share. The company has a constant dividend payout ratio of 30 per cent and achieves a 10 per cent return on new investments.
What is the predicted market value of a share in the company?
A $1·13
B $2·94
C $6·67
D $7·13
13. Which of the following need to be assumed when using the dividend valuation formula to estimate a share value?
1 The recent dividend, ‘D0’, is typical i.e. doesn’t vary significantly from historical trends
2 Growth will be constant
3 The cost of equity will remain constant
4 A majority shareholding is being purchased
A 1, 2 and 3 only
B 3 and 4 only
C 1 and 2 only
D 1, 2, 3 and 4
14. Which of the following best defines the market capitalisation for a company’s shares?
A When a company is listed ie goes ‘public’
B When a company issues new shares and thus increases its capital
C Current share price
D Share price × number of shares in issue
15. NCW Co is considering acquiring the ordinary share capital of CEW Co. CEW has for years generated an annual cash inflow of $10 million. For a one off investment of $6m in new machinery, earnings can be increased by $2m per annum. NCW has a cost of capital of 10%.
What is the value of CEW Co?
A $114m
B $120m
C $100m
D $94m
16. ABC Co is considering purchasing BBC Co. Both are listed companies. Recent information:
Earnings / $4m / $2m
P/E ratio / 21 / 16
A Co believes that if they were to purchase B Co the combined group would have earnings of $6.5 million (after synergies) and a P/E ratio of 19.
What is the maximum A Co should pay for B Co?
A $32 million
B $39.5 million
C $22.4 million
D $28 million
Question 1 – Rights issue and share price valuationDartig Co is a stock-market listed company that manufactures consumer products and it is planning to expand its existing business. The investment cost of $5 million will be met by a 1 for 4 rights issue. The current share price of Dartig Co is $2·50 per share and the rights issue price will be at a 20% discount to this. The finance director of Dartig Co expects that the expansion of existing business will allow the average growth rate of earnings per share over the last four years to be maintained into the foreseeable future.
The earnings per share and dividends paid by Dartig over the last four years are as follows:
2003 / 2004 / 2005 / 2006 / 2007
Earnings per share (cents) / 27.7 / 29.0 / 29.0 / 30.2 / 32.4
Dividend per share (cents) / 12.8 / 13.5 / 13.5 / 14.5 / 15.0
Dartig Co has a cost of equity of 10%. The price/earnings ratio of Dartig Co has been approximately constant in recent years. Ignore issue costs.
Required:
(a) Calculate the theoretical ex rights price per share prior to investing in the proposed business expansion. (3 marks)
(b) Calculate the expected share price following the proposed business expansion using the price/earnings ratio method. (3 marks)
(c) Discuss whether the proposed business expansion is an acceptable use of the finance raised by the rights issue, and evaluate the expected effect on the wealth of the shareholders of Dartig Co. (5 marks)
(d) Using the information provided, calculate the ex div share price predicted by the dividend growth model and discuss briefly why this share price differs from the current market price of Dartig Co. (6 marks)
(Amended ACCA F9 Financial Management December 2008 Q1(a) – (d))
Question 2 – Shares valuation methods, bonds valuation and gearing ratio
GWW Co is a listed company which is seen as a potential target for acquisition by financial analysts. The value of the company has therefore been a matter of public debate in recent weeks and the following financial information is available:
Year / 2009 / 2010 / 2011 / 2012
Profit after tax ($m) / 8.5 / 8.9 / 9.7 / 10.1
Total dividends ($m) / 5.0 / 5.2 / 5.6 / 6.0
Statement of financial position information for 2012
$m / $m
Non-current assets / 91.0
Current assets
Inventory / 3.8
Trade receivables / 4.5 / 8.3
Total assets / 99.3
Equity finance
Ordinary shares / 20.0
Reserves / 47.2 / 67.2
Non-current liabilities
8% bonds / 25.0
Current liabilities / 7.1
Total equity and liabilities / 99.3
The shares of GWW Co have a nominal (par) value of 50c per share and a market value of $4·00 per share. The cost of equity of the company is 9% per year. The business sector of GWW Co has an average price/earnings ratio of 17 times. The 8% bonds are redeemable at nominal (par) value of $100 per bond in seven years’ time and the before-tax cost of debt of GWW Co is 6% per year.
The expected net realisable values of the non-current assets and the inventory are $86·0m and $4·2m, respectively. In the event of liquidation, only 80% of the trade receivables are expected to be collectible.
Required:
(a) Calculate the value of GWW Co using the following methods:
(i) market capitalization (equity market value);
(ii) net asset value (liquidation basis);
(iii) price/earnings ratio method using the business sector average price/earnings ratio;
(iv) dividend growth model using:
(1) the average historic dividend growth rate;
(2) Gorden’s growth model (the bre model)
The total marks will be split equally between each part. (10 marks)
(b) Discuss the relative merits of the valuation methods in part (a) above in determining a purchase price for GWW Co. (8 marks)
(c) Calculate the following values for GWW Co:
(i) the before-tax market value of the bonds of GWW Co;
(ii) debt/equity ratio (book value basis);
(iii) debt/equity ratio (market value basis).
Discuss the usefulness of the debt/equity ratio in assessing the financial risk of GWW Co.
The total marks will be split equally between each part. (7 marks)
(Total 25 marks)
(ACCA F9 Financial Management December 2012 Q4)
Question 3 – P/E method, dividend valuation model and WACC
Corhig Co is a company that is listed on a major stock exchange. The company has struggled to maintain profitability in the last two years due to poor economic conditions in its home country and as a consequence it has decided not to pay a dividend in the current year. However, there are now clear signs of economic recovery and Corhig Co is optimistic that payment of dividends can be resumed in the future. Forecast financial information relating to the company is as follows: