The following scenario relates to questions 1–5.

CASE SCENARIO

Extracts from the financial statements of Bluebell Co, a listed company, are as follows:

A similar size competitor company has a price/earnings ratio of 12.5 times.

This competitor believes that if Bluebell Co were liquidated, property, plant and equipment would only realise $600 million, while 10% of trade receivables would be irrecoverable and inventory would be sold at $30 million less than its book value.

Separately, Bluebell Co is considering the acquisition of Dandelion Co, an unlisted company which is a supplier of Bluebell Co.

REQUIREMENT

Which of the following statements is correct?

The following scenario relates to questions 1–5.

CASE SCENARIO

Extracts from the financial statements of Bluebell Co, a listed company, are as follows:

A similar size competitor company has a price/earnings ratio of 12.5 times.

This competitor believes that if Bluebell Co were liquidated, property, plant and equipment would only realise $600 million, while 10% of trade receivables would be irrecoverable and inventory would be sold at $30 million less than its book value.

Separately, Bluebell Co is considering the acquisition of Dandelion Co, an unlisted company which is a supplier of Bluebell Co.

REQUIREMENT

Which of the following is/are indicators of market imperfections?

1. Low volume of trading in shares of smaller companies
2. Overreaction to unexpected news

The following scenario relates to questions 1–5.

CASE SCENARIO

Extracts from the financial statements of Bluebell Co, a listed company, are as follows:

A similar size competitor company has a price/earnings ratio of 12.5 times.

This competitor believes that if Bluebell Co were liquidated, property, plant and equipment would only realise $600 million, while 10% of trade receivables would be irrecoverable and inventory would be sold at $30 million less than its book value.

Separately, Bluebell Co is considering the acquisition of Dandelion Co, an unlisted company which is a supplier of Bluebell Co.

REQUIREMENT

When valuing Bluebell Co using asset-based valuations, which of the following statements is correct?

The following scenario relates to questions 1–5.

CASE SCENARIO

Extracts from the financial statements of Bluebell Co, a listed company, are as follows:

A similar size competitor company has a price/earnings ratio of 12.5 times.

This competitor believes that if Bluebell Co were liquidated, property, plant and equipment would only realise $600 million, while 10% of trade receivables would be irrecoverable and inventory would be sold at $30 million less than its book value.

Separately, Bluebell Co is considering the acquisition of Dandelion Co, an unlisted company which is a supplier of Bluebell Co.

REQUIREMENT

What is the value of Bluebell Co using the earnings yield method?

The following scenario relates to questions 1–5.

CASE SCENARIO

Extracts from the financial statements of Bluebell Co, a listed company, are as follows:

A similar size competitor company has a price/earnings ratio of 12.5 times.

This competitor believes that if Bluebell Co were liquidated, property, plant and equipment would only realise $600 million, while 10% of trade receivables would be irrecoverable and inventory would be sold at $30 million less than its book value.

Separately, Bluebell Co is considering the acquisition of Dandelion Co, an unlisted company which is a supplier of Bluebell Co.

REQUIREMENT

What is the value of Bluebell Co on a net realisable value basis?

The following scenario relates to questions 1–5.

CASE SCENARIO

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 20Y2

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.

REQUIREMENT

Assume that GWW Co's P/E ratio is 15. Its competitor's earnings yield is 6.25%.

When comparing GWW Co to its competitor, which of the following is correct?

The following scenario relates to questions 1–5.

CASE SCENARIO

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 20Y2

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.

REQUIREMENT

An investor believes that they can make abnormal returns by studying past share price movements.

In terms of capital market efficiency, to which of the following does the investor's belief relate?

The following scenario relates to questions 1–5.

CASE SCENARIO

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 20Y2

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.

REQUIREMENT

What is the value of GWW Co using the price/earnings ratio method (business sector average price/earnings ratio)?

The following scenario relates to questions 1–5.

CASE SCENARIO

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 20Y2

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.

REQUIREMENT

What is the value of GWW Co using the net asset value (liquidation basis)? (in $m to the nearest whole million

The following scenario relates to questions 1–5.

CASE SCENARIO

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 20Y2

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.

REQUIREMENT

What is the value of GWW Co using market capitalisation (equity market value)? (in $m to the nearest whole million)

The following scenario relates to questions 1–5.

CASE SCENARIO

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

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

REQUIREMENT

Which of the following options correctly matches the type of risk to its corresponding statement?

1. Risk linked to the extent to which the company's profits depend  on fixed, rather than variable, costs
2. Risk that shareholder cannot mitigate by holding a diversified investment portfolio
3. Risk that shareholder return fluctuates as a result of the level of debt the company undertakes

The following scenario relates to questions 1–5.

CASE SCENARIO

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

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

REQUIREMENT

Corhig Co plans to raise 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 The before-tax cost of debt of Corhig Co would increase to 6% per year. In order to stimulate economic activity the Government has reduced the tax rate for all large companies to 20% per year.

Assuming that the revised cost of equity is 14%, what is the revised weighted average after- tax cost of capital of Corhig Co following the new debt issue? (give your answer to 2 decimal places)

______%

The following scenario relates to questions 1–5.

CASE SCENARIO

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

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

REQUIREMENT

Assuming that the cost of equity is 12%, what is the present value of Corhig Co's Year 2 dividend?

The following scenario relates to questions 1–5.

CASE SCENARIO

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

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

REQUIREMENT

Which of the following statement is True?

1. A P/E valuation using average earnings of $3.63m would be more realistic than the P/E ratio method calculated above.
2. Using the average P/E ratio of similar companies is appropriate in this situation.

The following scenario relates to questions 1–5.

CASE SCENARIO

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

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

REQUIREMENT

Using Corhig Co's forecast earnings for Year 1 and the average P/E ratio of similar companies, what is the value of Corhig Co using the price/earnings ratio method?

$____ millions.

The following scenario relates to questions 1–5.

CASE SCENARIO

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.

REQUIREMENT

Close Co is considering raising finance via convertible bonds.

Which of the following statements is correct about the current market value of a convertible bond where conversion is expected?

The following scenario relates to questions 1–5.

CASE SCENARIO

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.

REQUIREMENT

The DGM has been used by financial analysts to value Close Co.

Which of the following statements about the DGM True?

1. It is very sensitive to changes in the growth rate.
2. It can only be used if dividends have been paid or are expected to be paid.

The following scenario relates to questions 1–5.

CASE SCENARIO

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.

REQUIREMENT

Calculate the value of Close Co using the earnings yield method. (in millions to 1 decimal places)

$_____ million.

The following scenario relates to questions 1–5.

CASE SCENARIO

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.

REQUIREMENT

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

$_____ million.

The following scenario relates to questions 1–5.

CASE SCENARIO

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.

REQUIREMENT

Calculate the value of Close Co using the net asset value method.

$_____ million.

The following scenario relates to questions 1–5.

CASE SCENARIO

WAW Co is an unlisted company that has performed well recently. It has been approached by a number of companies in the industry as a potential acquisition target.

The directors of WAW Co are looking to establish an approximate valuation of the company.

Recent information on the earnings per share and dividend per share of WAW Co is as follows:

WAW Co has an estimated cost of equity of 12% and $5m ordinary shares in issue with a par value of $0.50.

There has been no change in the number of ordinary shares in issue over this period.

WAW Co pays corporation tax at a rate of 20%.

Listed companies similar to WAW Co have a price/earnings ratio of 15.

REQUIREMENT

Which of the following statements are true about WAW Co's dividend policy?

1. Shareholders achieve steady dividend growth.
2. The dividend payout ratio is constant.
3. The dividend cover is 2.5.
4. Shareholders are indifferent between reinvesting in the business and the payment of a dividend.

The following scenario relates to questions 1–5.

CASE SCENARIO

WAW Co is an unlisted company that has performed well recently. It has been approached by a number of companies in the industry as a potential acquisition target.

The directors of WAW Co are looking to establish an approximate valuation of the company.

Recent information on the earnings per share and dividend per share of WAW Co is as follows:

WAW Co has an estimated cost of equity of 12% and $5m ordinary shares in issue with a par value of $0.50.

There has been no change in the number of ordinary shares in issue over this period.

WAW Co pays corporation tax at a rate of 20%.

Listed companies similar to WAW Co have a price/earnings ratio of 15.

REQUIREMENT

A high price/earnings ratio is usually seen as an indication that:

The following scenario relates to questions 1–5.

CASE SCENARIO

WAW Co is an unlisted company that has performed well recently. It has been approached by a number of companies in the industry as a potential acquisition target.

The directors of WAW Co are looking to establish an approximate valuation of the company.

Recent information on the earnings per share and dividend per share of WAW Co is as follows:

WAW Co has an estimated cost of equity of 12% and $5m ordinary shares in issue with a par value of $0.50.

There has been no change in the number of ordinary shares in issue over this period.

WAW Co pays corporation tax at a rate of 20%.

Listed companies similar to WAW Co have a price/earnings ratio of 15.

REQUIREMENT

What is the value of WAW Co using the price/earnings ratio method?

The following scenario relates to questions 1–5.

CASE SCENARIO

WAW Co is an unlisted company that has performed well recently. It has been approached by a number of companies in the industry as a potential acquisition target.

The directors of WAW Co are looking to establish an approximate valuation of the company.

Recent information on the earnings per share and dividend per share of WAW Co is as follows:

WAW Co has an estimated cost of equity of 12% and $5m ordinary shares in issue with a par value of $0.50.

There has been no change in the number of ordinary shares in issue over this period.

WAW Co pays corporation tax at a rate of 20%.

Listed companies similar to WAW Co have a price/earnings ratio of 15.

REQUIREMENT

Which of the following statements are problems in using the dividend growth model to value a company?

1. It is difficult to estimate future dividend growth.
2. It cannot be used for unlisted companies as they do not have a cost of equity.
3. It is inaccurate to assume that dividend growth will be constant.
4. It does not adjust for the value of holding a controlling interest in a company.

The following scenario relates to questions 1–5.

CASE SCENARIO

WAW Co is an unlisted company that has performed well recently. It has been approached by a number of companies in the industry as a potential acquisition target.

The directors of WAW Co are looking to establish an approximate valuation of the company.

Recent information on the earnings per share and dividend per share of WAW Co is as follows:

WAW Co has an estimated cost of equity of 12% and $5m ordinary shares in issue with a par value of $0.50.

There has been no change in the number of ordinary shares in issue over this period.

WAW Co pays corporation tax at a rate of 20%.

Listed companies similar to WAW Co have a price/earnings ratio of 15.

REQUIREMENT

What is the value of a share in WAW Co using the dividend growth model?

The following scenario relates to questions 1–5.

CASE SCENARIO

DFE Co is hoping to invest in a new project. DFE Co's gearing is slightly above the industry average, so when seeking finance for the new project DFE Co opts for equity finance.

The board of DFE Co recently appointed a media liaison officer as they believe the timing and method of public announcements (such as the investment in a large project) is important in managing the value of DFE Co's shares.

DFE Co has 8% convertible loan notes in issue which are redeemable in 5 years' time at their nominal value of $100 per loan note. Alternatively, each loan note could be converted after 5 years into 70 equity shares with a nominal value of $1 each.

The equity shares of DFE Co are currently trading at $1.25 per share and this share price is expected to grow by 4% per year. The before-tax cost of debt of DFE Co is 10% and the after-tax cost of debt of DFE Co is 7%.

REQUIREMENT

Which of the following could cause the interest yield curve to steepen?

1. Increased uncertainty about the future
2. Heightened expectations of an increase in interest rates
3. The expectation that interest rate decreases will happen earlier than previously thought

The following scenario relates to questions 1–5.

CASE SCENARIO

DFE Co is hoping to invest in a new project. DFE Co's gearing is slightly above the industry average, so when seeking finance for the new project DFE Co opts for equity finance.

The board of DFE Co recently appointed a media liaison officer as they believe the timing and method of public announcements (such as the investment in a large project) is important in managing the value of DFE Co's shares.

DFE Co has 8% convertible loan notes in issue which are redeemable in 5 years' time at their nominal value of $100 per loan note. Alternatively, each loan note could be converted after 5 years into 70 equity shares with a nominal value of $1 each.

The equity shares of DFE Co are currently trading at $1.25 per share and this share price is expected to grow by 4% per year. The before-tax cost of debt of DFE Co is 10% and the after-tax cost of debt of DFE Co is 7%.

REQUIREMENT

In relation to DFE Co hedging interest rate risk, which of the following statements is correct?

The following scenario relates to questions 1–5.

CASE SCENARIO

DFE Co is hoping to invest in a new project. DFE Co's gearing is slightly above the industry average, so when seeking finance for the new project DFE Co opts for equity finance.

The board of DFE Co recently appointed a media liaison officer as they believe the timing and method of public announcements (such as the investment in a large project) is important in managing the value of DFE Co's shares.

DFE Co has 8% convertible loan notes in issue which are redeemable in 5 years' time at their nominal value of $100 per loan note. Alternatively, each loan note could be converted after 5 years into 70 equity shares with a nominal value of $1 each.

The equity shares of DFE Co are currently trading at $1.25 per share and this share price is expected to grow by 4% per year. The before-tax cost of debt of DFE Co is 10% and the after-tax cost of debt of DFE Co is 7%.

REQUIREMENT

What is the current market value of each convertible loan note? (to 2 decimal places)

The following scenario relates to questions 1–5.

CASE SCENARIO

DFE Co is hoping to invest in a new project. DFE Co's gearing is slightly above the industry average, so when seeking finance for the new project DFE Co opts for equity finance.

The board of DFE Co recently appointed a media liaison officer as they believe the timing and method of public announcements (such as the investment in a large project) is important in managing the value of DFE Co's shares.

DFE Co has 8% convertible loan notes in issue which are redeemable in 5 years' time at their nominal value of $100 per loan note. Alternatively, each loan note could be converted after 5 years into 70 equity shares with a nominal value of $1 each.

The equity shares of DFE Co are currently trading at $1.25 per share and this share price is expected to grow by 4% per year. The before-tax cost of debt of DFE Co is 10% and the after-tax cost of debt of DFE Co is 7%.

REQUIREMENT

How efficient does the DFE Co board believe the markets to be?

The following scenario relates to questions 1–5.

CASE SCENARIO

DFE Co is hoping to invest in a new project. DFE Co's gearing is slightly above the industry average, so when seeking finance for the new project DFE Co opts for equity finance.

The board of DFE Co recently appointed a media liaison officer as they believe the timing and method of public announcements (such as the investment in a large project) is important in managing the value of DFE Co's shares.

DFE Co has 8% convertible loan notes in issue which are redeemable in 5 years' time at their nominal value of $100 per loan note. Alternatively, each loan note could be converted after 5 years into 70 equity shares with a nominal value of $1 each.

The equity shares of DFE Co are currently trading at $1.25 per share and this share price is expected to grow by 4% per year. The before-tax cost of debt of DFE Co is 10% and the after-tax cost of debt of DFE Co is 7%.

REQUIREMENT

What is the capital structure theory that DFE Co appears to subscribe to?