Reference no: EM131457869

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