Oliver plc is a medium sized all-equity financed company which operates two divisions. Division A has...

 

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Oliver plc is a medium sized all-equity financed company which operates two divisions. Division A has been particularly successful over the years, consistently increasing its earnings by reinvesting in projects which yield an average return of 25%. It is anticipated that this position will continue, with earnings of £8m expected in 2020. The projects within division A have a beta risk factor of 1.6. Division B, however, has been in decline for a long period of time with earnings falling by an average of 5% per annum. The earnings in 2018 were £5m. Projects in this division have a beta risk factor of 1.1. At the end of 2018 Oliver plc received a cash offer for this division of £8m. If accepted the money received would, for the time being, be invested in the risk-free security. The returns on the risk-free security and on the market portfolio are currently 9% and 19% respectively. It is expected that these rates will continue to prevail. Oliver plc has a policy of paying out 40% of its earnings as dividends. Ignore taxation. Required (i) Advise the directors of Oliver plc whether or not they should accept the offer of £8m for division B. (ii) (iii) Calculate the expected earnings yield on the equity of Oliver plc if the offer is accepted and all the interest on the risk-free security is paid out as dividend together with the 40% of earnings from division A. Calculate the effect in 2020 on a shareholder in Oliver plc of the dividend to be received if the offer is and is not accepted. Comment on whether a shareholder is better or worse off if the offer goes ahead. Oliver plc is a medium sized all-equity financed company which operates two divisions. Division A has been particularly successful over the years, consistently increasing its earnings by reinvesting in projects which yield an average return of 25%. It is anticipated that this position will continue, with earnings of £8m expected in 2020. The projects within division A have a beta risk factor of 1.6. Division B, however, has been in decline for a long period of time with earnings falling by an average of 5% per annum. The earnings in 2018 were £5m. Projects in this division have a beta risk factor of 1.1. At the end of 2018 Oliver plc received a cash offer for this division of £8m. If accepted the money received would, for the time being, be invested in the risk-free security. The returns on the risk-free security and on the market portfolio are currently 9% and 19% respectively. It is expected that these rates will continue to prevail. Oliver plc has a policy of paying out 40% of its earnings as dividends. Ignore taxation. Required (i) Advise the directors of Oliver plc whether or not they should accept the offer of £8m for division B. (ii) (iii) Calculate the expected earnings yield on the equity of Oliver plc if the offer is accepted and all the interest on the risk-free security is paid out as dividend together with the 40% of earnings from division A. Calculate the effect in 2020 on a shareholder in Oliver plc of the dividend to be received if the offer is and is not accepted. Comment on whether a shareholder is better or worse off if the offer goes ahead.

Answer rating: 100% (QA)

Part i Cost of equity Ke Rf beta x Rm Rf Cost of equity for Div B KeB 9 11 x 19 9 20 Earnings in yea... View the full answer