QUESTION 1

Maximum Limited is a listed company which your company is considering acquiring. In considering the acquisition, you have been asked to undertake various valuations and analyses of the business. You have sourced the following financial information, taken from the most recent set of financial statements as well as analyst reports:

EXTRACT FROM STATEMENT OF FINANCIAL POSITION OF MAXIMUM LIMITED AS AT 31 MAY 2019

EQUITY AND LIABILITIES

EQUITY

Ordinary shares R 900 000

Retained Earnings R 920 000

Preference Share Capital R 80 000

NONCURRENT LIABILITIES

Corporate bonds R 425 000

Bank Loans R 875 000

Forecast profit after tax, retained earnings and dividends:

DETAILS 2020 2021 2022

Profit after tax R 475 000 R 520 000 R 560 000

Retained earnings R 225 000 R 290 000 R 300 000

Dividends R 165 000 R 180 000 R 170 000

Included in profit after tax:

DETAILS 2020 2021 2022

Depreciation and amortisation R 190 000 R 185 000 R 275 000

Interest expense R 40 000 R 65 000 R 82 500

Additional information:

The cost of equity is 15% and the weighted average cost of capital is 12%;

Analysts have estimated the company's Beta to be 0. 75;

The average industry price/ earnings ratio is six. An upward adjustment of three needs to be made to the Price Earnings Ratio for company specific risks.

The carrying values of the corporate bonds and bank loans are considered to approximate their market values;

Thirty percent (30%) of retained earnings will be reinvested in the business as funding for expansion and a value equivalent to forty percent (40%) of the annual depreciation and amortisation charge will be used for asset replacement costs;

Analysts have forecasted the dividend and earnings growth rate post 2022 to be 10% per annum;

The corporate tax rate is 28%.

a) Calculate the value of Maximum Ltd using the price earnings (P/ E) valuation model. Hint: Use the 2020 forecast as basis for the calculation

b) Advise the management board of any two reasons why you prefer not to use the dividend growth model to value companies.

c) Calculate the Free Cash Flow of Maximum Ltd for 2020 only.