ACCA FM Syllabus F. Business Valuations - Dividend Valuation - Past Papers ^{4 / 5}

Ring Co has in issue ordinary shares with a nominal value of $0·25 per share. These shares are traded on an efficient capital market. It is now 20X6 and the company has just paid a dividend of $0·450 per share. Recent dividends of the company are as follows:

Ring Co also has in issue loan notes which are redeemable in seven years’ time at their nominal value of $100 per loan note and which pay interest of 6% per year.

The finance director of Ring Co wishes to determine the value of the company.

Ring Co has a cost of equity of 10% per year and a before-tax cost of debt of 4% per year. The company pays corporation tax of 25% per year.

Using the dividend growth model, what is the market value of each ordinary share?

A. $8·59
B. $9·00
C. $9·45
D. $7·77

Ring Co has in issue ordinary shares with a nominal value of $0·25 per share. These shares are traded on an efficient capital market. It is now 20X6 and the company has just paid a dividend of $0·450 per share. Recent dividends of the company are as follows:

Ring Co also has in issue loan notes which are redeemable in seven years’ time at their nominal value of $100 per loan note and which pay interest of 6% per year.

The finance director of Ring Co wishes to determine the value of the company.

Ring Co has a cost of equity of 10% per year and a before-tax cost of debt of 4% per year. The company pays corporation tax of 25% per year.

The finance director of Ring Co has been advised to calculate the net asset value (NAV) of the company.

Which of the following statements about valuation methods is true?

A. The earnings yield method multiplies earnings by the earnings yield
B. The equity market value is number of shares multiplied by share price, plus the market value of debt
C. The dividend valuation model makes the unreasonable assumption that average dividend growth is constant
D. The price/earnings ratio method divides earnings by the price/earnings ratio

The shares of GWW Co have a nominal (par) value of 50c per share and a market value of $4·00 per share. The business sector of GWW Co has an average price/earnings ratio of 17 times.

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:
(b) Discuss briefly the advantages and disadvantages of using the dividend growth model to value the shares of GWW Co. (4 marks)

DD Co has a dividend payout ratio of 40% and has maintained this payout ratio for several years. The current dividend per share of the company is 50c per share and it expects that its next dividend per share, payable in one year’s time, will be 52c per share.

The capital structure of the company is as follows:

Bond A will be redeemed at par in ten years’ time and pays annual interest of 9%. The cost of debt of this bond is 9·83% per year. The current ex interest market price of the bond is $95·08.

Bond B will be redeemed at par in four years’ time and pays annual interest of 8%. The cost of debt of this bond is 7·82% per year. The current ex interest market price of the bond is $102·01.

DD Co has a cost of equity of 12·4%. Ignore taxation.

Required:
(a) Calculate the following values for DD Co:
(i) ex dividend share price, using the dividend growth model; (3 marks)

The following financial information relates to MFZ Co, a listed company:

MFZ Co has 12 million ordinary shares in issue and has not issued any new shares in the period under review. The company is financed entirely by equity, and is considering investing $9•2 million of new finance in order to expand existing business operations. This new finance could be either long-term debt finance or new equity via a rights issue. The rights issue price would be at a 20% discount to the current share price. Issue costs of $200,000 would have to be met from the cash raised, whether the new finance was equity or debt.

The annual report of MFZ Co states that the company has three financial objectives:

Required:

Calculate the total equity market value of MFZ Co for 2014 using the dividend growth model and briefly discuss why the dividend growth model value may differ from the current equity market value. (5 marks)

Card Co has in issue 8 million shares with an ex dividend market value of $7·16 per share. A dividend of 62 cents per share for 2013 has just been paid. The pattern of recent dividends is as follows:

Card Co also has in issue 8•5% bonds redeemable in five years’ time with a total nominal value of $5 million. The market value of each $100 bond is $103•42. Redemption will be at nominal value.
Card Co is planning to invest a significant amount of money into a joint venture in a new business area. It has identified a proxy company with a similar business risk to the joint venture. The proxy company has an equity beta of 1•038 and is financed 75% by equity and 25% by debt, on a market value basis.

The current risk-free rate of return is 4% and the average equity risk premium is 5%. Card Co pays profit tax at a rate of 30% per year and has an equity beta of 1•6.

Required:

Calculate the cost of equity of Card Co using the dividend growth model. (3 marks)

GXG Co is an e-business which designs and sells computer applications (apps) for mobile phones. The company needs to raise $3,200,000 for research and development and is considering three financing options.

Option 1
GXG Co could suspend dividends for two years, and then pay dividends of 25 cents per share from the end of the third year, increasing dividends annually by 4% per year in subsequent years. Dividends in recent years have grown by 3% per year.

Option 2
GXG Co could seek a stock market listing, raising $3·2 million after issue costs of $100,000 by issuing new shares to new shareholders at a price of $2·50 per share.

Option 3
GXG Co could issue $3,200,000 of bonds paying annual interest of 6%, redeemable after ten years at par.

Recent financial information relating to GXG Co is as follows:

Under options 2 and 3, the funds invested would earn a before-tax return of 18% per year.

The profit tax rate paid by the company is 20% per year.

GXG Co has a cost of equity of 9% per year, which is expected to remain constant.

Required:

Using the dividend valuation model, calculate the value of GXG Co under option 1, and advise whether option 1 will be acceptable to shareholders.

(6 marks)

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:

Statement of financial position information for 2012

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:

Calculate the value of GWW Co dividend growth model using:

(1) the average historic dividend growth rate;
(2) Gordon’s growth model (the bre model).

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:

The company is optimistic that earnings and dividends will increase after Year 3 at a constant annual rate of 3% per year.

Corhig Co currently has a before-tax cost of debt of 5% per year and an equity beta of 1•6. On a market value basis, the company is currently financed 75% by equity and 25% by debt.

During the course of the last two years the company acted to reduce its gearing and was able to redeem a large amount of debt. Since there are now clear signs of economic recovery, Corhig Co plans to raise further debt in order to modernise some of its non-current assets and to support the expected growth in earnings.

This additional debt would mean that the capital structure of the company would change and it would be financed 60% by equity and 40% by debt on a market value basis. The before-tax cost of debt of Corhig Co would increase to 6% per year and the equity beta of Corhig Co would increase to 2.

The risk-free rate of return is 4% per year and the equity risk premium is 5% per year. In order to stimulate economic activity the government has reduced profit tax rate for all large companies to 20% per year.

The current average price/earnings ratio of listed companies similar to Corhig Co is 5 times.

Required:

Calculate the current cost of equity of Corhig Co and, using this value, calculate the value of the company using the dividend valuation model.

Recent financial information relating to Close Co, a stock market listed company, is as follows.

Financial analysts have forecast that the dividends of Close Co will grow in the future at a rate of 4% per year. This is slightly less than the forecast growth rate of the profit after tax (earnings) of the company, which is 5% per year.

The finance director of Close Co thinks that, considering the risk associated with expected earnings growth, an earnings yield of 11% per year can be used for valuation purposes.

Close Co has a cost of equity of 10% per year and a before-tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal value in six years’ time. Close Co pays tax at an annual rate of 30% per year and the ex-dividend share price of the company is $8·50 per share.

Required:

(a) Calculate the value of Close Co using the dividend growth model

(b) Discuss the weaknesses of the dividend growth model as a way of valuing a company and its shares.