Question 2b
The treasury department of Chawan Co, a listed company, aims to maintain a portfolio of around $360 million consisting of equity shares, corporate bonds and government bonds, which it can turn into cash quickly for investment projects. Chawan Co is considering disposing 27 million shares, valued at $2·15 each, which it has invested in Oden Co. The head of Chawan Co’s treasury department is of the opinion that, should the decision be made to dispose of its equity stake in Oden Co, this should be sold through a dark pool network and not sold on the stock exchange where Oden Co’s shares are listed. In the last few weeks, there have also been rumours that Oden Co may become subject to a takeover bid.
Oden Co operates in the travel and leisure (T&L) sector, and the poor weather conditions in recent years, coupled with a continuing recession, has meant that the T&L sector is under-performing. Over the past three years, sales revenue fell by an average of 8% per year in the T&L sector. However, there are signs that the economy is starting to recover, but this is by no means certain.
Given below are extracts from the recent financial statements and other financial information for Oden Co and the T&L sector.
Oden Co
Year ending 31 May (all amounts in $m)
| 2013 | 2014 | 2015 | |
|---|---|---|---|
| Total non-current assets | 972 | 990 | 980 |
| Total current assets | 128 | 142 | 126 |
| Total assets | 1,100 | 1,132 | 1,106 |
| Equity | |||
| Ordinary shares ($0·50) | 300 | 300 | 300 |
| Reserves | 305 | 329 | 311 |
| Total equity | 605 | 629 | 611 |
| Non-current liabilities | |||
| Bank loans | 115 | 118 | 100 |
| Bonds | 250 | 250 | 260 |
| Total non-current liabilities | 365 | 368 | 360 |
| Current liabilities | |||
| Trade and other payables | 42 | 45 | 37 |
| Bank overdraft | 88 | 90 | 98 |
| Total current liabilities | 130 | 135 | 135 |
| Total equity and liabilities | 1,100 | 1,132 | 1,106 |
| Oden Co | |||
|---|---|---|---|
| Year ending 31 May (all amounts in $m) | |||
| 2013 | 2014 | 2015 | |
| Sales revenue | 1,342 | 1,335 | 1,185 |
| Operating profit | 218 | 203 | 123 |
| Finance costs | (23) | (27) | (35) |
| Profit before tax | 195 | 176 | 88 |
| Taxation | (35) | (32) | (16) |
| Profit for the year | 160 | 144 | 72 |
| 2012 | 2013 | 2014 | 2015 | |
|---|---|---|---|---|
| Oden Co average share price ($) | 2·10 | 2·50 | 2·40 | 2·20 |
| Oden Co dividend per share ($) | 0·15 | 0·18 | 0·20 | 0·15 |
| T&L sector average share price ($) | 3·80 | 4·40 | 4·30 | 4·82 |
| T&L sector average earnings per share ($) | 0·32 | 0·36 | 0·33 | 0·35 |
| T&L sector average dividend per share ($) | 0·25 | 0·29 | 0·29 | 0·31 |
| Oden Co’s equity beta | 1·5 | 1·5 | 1·6 | 2·0 |
| T&L sector average equity beta | 1·5 | 1·4 | 1·5 | 1·6 |
The risk-free rate and the market return have remained fairly constant over the last ten years at 4% and 10% respectively.
Required:
(b) Discuss whether or not Chawan Co should dispose of its equity stake in Oden Co. Provide relevant calculations to support the discussion.
Note: Up to 10 marks are available for the calculations. (20 marks)