ACCA FM Syllabus F. Business Valuations - Earnings Yield - Past Papers ^{3 / 5}

June 2015

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Question 2abc

Chad Co is a stock-market-listed company which has managed to increase earnings over the last year. As a result, the board of directors has increased the dividend payout ratio from 40·0% for the year to March 2014 to 41·4% for the year to March 2015. Chad Co has a cost of equity of 12·5%. The following information is also available:

Year to March	2014 $000	2015 $000
Earnings	13,200	13,840
Ordinary shares	8,000	8,000

The nominal value of the ordinary shares of Chad Co is $0·50 per share. Listed companies similar to Chad Co have an earnings yield of 8·2%.

Required:
(a) Calculate the equity market value of Chad Co using the dividend growth model. (3 marks)

(b) Calculate the equity market value of Chad Co using the earnings yield method. (2 marks)

(c) Discuss the relative merits of the dividend growth model and the earnings yield method as a way of valuing Chad Co. (5 marks)

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December 2011

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Question 3a iii

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

	$m
profit after tax (earnings)	66.6
dividends	40.0

statement of financial position information
	$m	$m
non current assets		595
current assets		125
		-------
total assets		720
		-------

current liabilities		70
equity
ordinary shares ($1 nominal)	80
reserves	410
	-------
		490
non current liabilities
6% bank loan	40
8% bonds ($100 nominal)	120
	-------
		160
		-------
		720
		-------

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:

Calculate the value of Close Co using the earnings yield method

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