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Question 2b
Recent information on the earnings per share and share price of Par Co is as follows:
Par Co currently has the following long-term capital structure:
| Year | 2011 | 2012 | 2013 | 2014 |
|---|---|---|---|---|
| Earnings per share (cents) | 64 | 68 | 70 | 62 |
| Year-end share price ($) | 9·15 | 9·88 | 10·49 | 10·90 |
| $m | $m | |
|---|---|---|
| Equity finance | ||
| Ordinary shares | 30·0 | |
| Reserves | 38·4 | 68·4 |
| Non-current liabilities | ||
| Bank loans | 15·0 | |
| 8% convertible loan notes | 40·0 | 55·0 |
| Total equity and liabilities | 123·4 |
The 8% loan notes are convertible into eight ordinary shares per loan note in seven years’ time. If not converted, the loan notes can be redeemed on the same future date at their nominal value of $100. Par Co has a cost of debt of 9% per year.
The ordinary shares of Par Co have a nominal value of $1 per share and have been traded on a large stock exchange for many years. Listed companies similar to Par Co have been recently reported to have an average price/earnings ratio of 12 times.
Required:
(b) Calculate the share price of Par Co using the price/earnings ratio method and discuss the problems in using this method of valuing the shares of a company. (5 marks)