Part A -
QUESTION 1 -
The following information relates to Block Ltd, a manufacturing company from which you are required to do a valuation.
Income Statement (Profit and Loss) for year ended:
|
30 June 20X9
|
|
Sales Revenue
|
|
800,000
|
|
Less Expenses
|
|
|
|
Cost of Sales
|
500,000
|
|
|
Selling Expenses
|
90,000
|
|
|
General & Admin Expenses
|
90,000
|
|
|
Interest Expense
|
20,000
|
|
|
|
700,000
|
|
|
100,000
|
|
Income from investments
|
|
20,000
|
|
Profit before tax
|
|
120,000
|
|
Taxation
|
|
40,000
|
|
Net Profit
|
|
$80,000
|
Statement of Financial Position (Balance Sheet) as at:
|
30 June 20X9
|
30 June 20X8
|
|
Assets
|
|
|
|
|
|
Cash
|
|
50,000
|
|
70,000
|
|
Accounts Receivable
|
|
70,000
|
|
80,000
|
|
Inventory
|
|
135,000
|
|
140,000
|
|
Plant & Buildings
|
700,000
|
|
550,000
|
|
|
Less accumulated deprec
|
(150,000)
|
550,000
|
(100,000)
|
450,000
|
|
|
$805,000
|
|
$740,000
|
|
Liabilities & Equity
|
|
|
|
|
|
Trade Creditors
|
|
85,000
|
|
50,000
|
|
Current portion- Interest-
bearing loans
|
|
40,000
|
|
20,000
|
|
Interest Bearing Loans
|
|
260,000
|
|
205,000
|
|
Share Capital
|
|
320,000
|
|
380,000
|
|
Retained Profits
|
|
50,000
|
|
60,000
|
|
General Reserve
|
|
50,000
|
|
25,000
|
|
Total Equity + Liabilities
|
|
$805,000
|
|
$740,000
|
Additional Information -
- The yield on current government securities is 6%
- Risk premium is 8%
- Unlevered beta for the industry from which Block Ltd belongs is 0.90
- Total shares on issue as at 30th June 20X9 - 100,000 shares
REQUIRED:
a) Calculate FCFF for the year ended 30 June 20X9, treating cash as part of working capital.
b) Adjust FCFF to determine FCFE for the year ended 30 June 20X9.
c) Calculate the cost of equity for Block Ltd
QUESTION 2 -
1. What factors would you consider important in determining the stable growth rate for a company that manufactures vaccines?
2. Explain how beta can be estimated from market data and the relevance of a low R2?
QUESTION 3 -
a) Calculate the appropriate cost of equity for a company, Mars Ltd with beta of 1.4 (source: Boombag Ltd), using the geometric growth rate to determine the risk free rate and market premium from the following financial data,:-
|
Time period
|
Price index
|
Accumulation
Index
|
Yield on
government
security
|
|
- 5 years
|
2809
|
12105
|
|
|
- 4 years
|
3056
|
14441
|
4%
|
|
- 3 years
|
3248
|
15166
|
6%
|
|
- 2 years
|
3267
|
16701
|
8%
|
|
- 1 years
|
2961
|
15351
|
5%
|
|
current year
|
3311
|
17786
|
7%
|
b) According to reliable sources, Boombag Ltd estimate betas based on weekly data over the last 5 years. You are also aware that Mars Ltd [(a) above] has operated with D/E ratio of 2.0 over this period and due to a recent restructure has changed its D/E ratio to 0.7. Re-estimate the cost of equity for Mars Ltd if the tax rate is 30%.
QUESTION 4 -
Alpha Ltd acquired all of the shares of Delta on 1 April 20X7, paying $20 cash for every share in Delta Ltd during a horizontal takeover. The takeover is reported to yield an annual cost savings of $10m (after-tax) for 30 years, after which time any savings due to economies of scale is meant to disappear.
Other data collected immediately before the takeover announcement:
|
Alpha Ltd
|
Delta Ltd
|
|
Share price
|
$10
|
$15
|
|
Outstanding shares
|
100m
|
10m
|
|
Beta
|
1.5
|
2.0
|
REQUIRED:
a) Determine the equity value of the merged firm (assuming Rf= 5%, Rm-Rf = 6%). Assume that Alpha's beta is unaffected by the takeover.
b) Identify the target shareholders' gain or loss.
c) Identify the acquiring company shareholders' gain or loss.
d) Re-calculate answers a) - c) if Alpha had made an equivalent takeover by share exchange (equivalent to $20 per share cash offer).
QUESTION 5 -
Phuong is the leading analyst for The Daisy Valuations Company and recently had asked one of her junior colleagues, Graeme, to perform a valuation of Omega Ltd, an investment company. Graeme performed a top down analysis of Omega using a free cash flow methodology and incorporating 'pro-forma' financial statements. Phuong is concerned with some aspects of Graeme's valuation and has asked for your opinion. In particular Phuong is concerned with his treatment of Revenues, Investments and Taxation.
Background information on Omega Ltd
Omega is an investment company, investing in shares of companies listed on the local stock exchange. The company's investment strategy is to invest in companies that have an established record of paying regular dividends that are franked (franked dividends). Omega's portfolio consists almost entirely of industrial stocks. Omega derives revenue from dividends that it receives from its investments and capital gains (losses) when it sells shares. The stock exchange has experienced a bull market over the past 5 years.
The Income Statement and Balance Sheet for Omega over the last 5 years is as follows.
Income Statement
|
20X7
|
20X6
|
20X5
|
20X4
|
20X3
|
|
Dividend Income
|
122
|
104
|
67
|
63
|
55
|
|
Realised Gains from sale of investments
|
38
|
11
|
17
|
17
|
14
|
|
Tax Expense
|
16
|
10
|
5
|
5
|
4
|
|
Net profit
|
144
|
105
|
79
|
75
|
65
|
Income Statement
|
20X7
|
20X6
|
20X5
|
20X4
|
20X3
|
|
Assets
|
|
|
|
|
|
|
Current assets
|
195
|
231
|
297
|
169
|
60
|
|
Investments
|
3,111
|
2,558
|
1,914
|
1,556
|
1,300
|
|
Total assets
|
3,306
|
2,789
|
2,211
|
1,725
|
1,360
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
Current liabilities
|
6
|
15
|
11
|
6
|
10
|
|
Deferred tax liabilities
|
514
|
391
|
249
|
181
|
150
|
|
Net Assets
|
2,786
|
2,383
|
1,951
|
1,538
|
1,200
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
|
Share capital
|
1,219
|
1,120
|
1,049
|
809
|
750
|
|
Unrealised gains on marketable securities
|
1,238
|
1,150
|
808
|
644
|
400
|
|
Retained profits
|
329
|
113
|
94
|
85
|
50
|
|
Total equity
|
2,786
|
2,383
|
1,951
|
1,538
|
1,200
|
Forecasting revenues
Graeme has performed an analysis of Omega and has reasoned that because it has shares in other companies it is affected in much the same way as the economy in general. Graeme deflated annual GDP (remove inflation from GDP estimates) for the past 3 years data and then regressed Omega's Dividend Income against the adjusted GDP for the same period and produced the following equation from which future revenues were forecasted: Omega revenue = 400 + 0.001GDP.
Forecasting investments
Graeme determined that Investments not only increased/ decreased as stocks were purchased/ sold but also due to the fact that investments were re-valued to market value at the end of each financial year. The value increment/ decrement is treated as unrealised and is not recognised as part of income by Omega. Instead the unrealised gains/ losses are accumulated as a reserve.
Graeme therefore determined Investments as a function of dividend revenue for future projections based upon the average over the past 5 year years (average 2,500%). Because of this high percentage the forecasted free cash flows derived from the pro-forma financial statements were negative.
Forecasting tax expense
Graeme calculated the average effective tax rate for Omega (by dividing tax expense by income before tax) over the 5 year period as being 7.4% and then adjusted the effective tax rate in line with the marginal tax rate over the next 5 years as follows:
|
20X8
|
20X9
|
20X10
|
20X11
|
20X12
|
|
12%
|
16%
|
20%
|
25%
|
30%
|
In a conversation with the company's accountant, Graeme also determined that Omega recognised Tax expense on unrealised gains and losses in addition to other income even though these gain and losses do not appear in the Income Statement (instead unrealised gains and losses are accumulated in a reserve account). Further the recognition of tax on unrealised gains/losses also gave rise to a significant Deferred tax liability. Graeme determined that such items as irrelevant and therefore ignored the Deferred tax liability in his projections.
REQUIRED: Advise Phuong on Graeme's valuation methodology for Omega with respect to the treatment of Revenues, Investments and Taxation.
Part B -
Question -
Delta Ltd owns 25% of the shares in another company, Zeta Ltd, which in turn has a 10% shareholding in Delta. A third company, Arti Ltd, is interested in taking over the two companies. From the following information, how much should Arti Ltd pay for the two companies in total and how much are individual shares in both companies worth.
|
|
Delta
|
Zeta
|
|
FCFE from own operations (in perpetuity)
|
$10m
|
$15m
|
|
Cost of equity
|
15%
|
10%
|
|
No of shares
|
2m
|
2m
|
Attachment:- Assignment Files.rar