PANGOLIN Co 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 PANGOLIN Co is optimistic

that payment of dividends can be resumed in the future. Forecast financial information

relating to the company is as follows:

Year

Earnings TZS

Dividends TZS Nil The company is optimistic that earnings and dividends will increase after Year at a

constant annual rate of per year.

PANGOLIN Co currently has a beforetax cost of debt of per year and an equity beta

of On a market value basis, the company is currently financed by equity and

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, PANGOLIN Co plans to raise further debt in order to modernize 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

by equity and by debt on a market value basis. The beforetax cost of debt of

PANGOLIN Co would increase to per year and the equity beta of PANGOLIN Co

would increase to

The riskfree rate of return is per year and the equity risk premium is per year. In

order to stimulate economic activity the government has reduced profit tax rate for all

large companies to per year.

The current average priceearnings ratio of listed companies similar to PANGOLIN Co is

times

Required:

a Estimate the value of PANGOLIN Co using the priceearnings ratio method and

discuss the usefulness of the variables that you have used.

b Calculate the current cost of equity of PANGOLIN Co and, using this value,

calculate the value of the company using the dividend valuation model.

c Calculate the current weighted average aftertax cost of capital of PANGOLIN Co

and the weighted average aftertax cost of capital following the new debt issue,

and comment on the difference between the two values.

Discuss how the shareholders of PANGOLIN Co can assess the extent to which they

face business risk, explaining the nature of the risk being assessed.

Answer rating: 100% (QA)

a To estimate the value of PANGOLIN Co using the priceearnings ratio method we first need to determine the appropriate PE ratio A common approach is to use the average PE ratio of comparable firms in ... View the full answer