The managing directors of Wrack plc are considering what value to place on Trollope plc, a company which they are planning to take over in the near future. Wrack plc's share price is currently £4.21 and the company's earnings per share stand at 29p. Wrack's weighted average cost of capital is 12 per cent.
The board estimates that annual after-tax synergy benefits resulting from the takeover will be £5m, that Trollope's distributable earnings will grow at an annual rate of 2 per cent and that duplication will allow the sale of £25m of assets, net of corporate tax (currently standing at 30 per cent), in a year's time. Information referring to
Trollope plc:
Financial position statement of Trollope plc
...............................................................£m
Non-current assets.......................................296
Current assets .............................................70
Total assets................................................366
Equity
Ordinary shares (£1) ....................................156
Reserves....................................................75
.............................................................231
7% bonds..................................................83
Current liabilities.........................................52
Total liabilities..........................................366
Statement of profit or loss extracts
..................................................................................£m
Profit before interest and tax..............................................76.0
Interest payments.............................................................8.3
Profit before tax............................................................67.7
Taxation......................................................................20.3
Distributable earnings......................................................47.4
Other information:
Current ex div share price................................................£2.25
Latest dividend payment...................................................16p
Past four years' dividend payments...................13p, 13.5p, 14p, 15p
Trollope's equity beta.......................................................1.15
Treasury bill yield............................................................5%
Return of the market.......................................................12%
(a) Given the above information, calculate the value of Trollope plc using the following valuation methods:
(i) Price/earnings ratio;
(ii) Dividend valuation method;
(iii) Discounted cash flow method.
(b) Discuss the problems associated with using the above valuation techniques. Which of the values would you recommend the board of Wrack to use?
(c) Critically discuss which factors will influence a company to finance a takeover by either a share-for-share offer or a cash offer financed by an issue of bonds.