Activity 1: Asset valuation Activity 2: (continuation of Activity

Transit Co’s latest statement of financial position is shown below: Transit Co’s average pre-tax earning
average year end asset base for the
Non-current assets 1,350 The average (pre-tax) return on tang
Current assets 1,030 is 25% and Transit Co’s weighted av
Total assets 2,380 Required
Using CIV, calculate the value of Tra
Share capital 240 240 1 - Estimate the profit that would be
Retained earnings 860 860 industry average expected return.
Total equity 1,100 1,100 2 - Calculate the present value of an
Current liabilities 700 700 using the WACC as the discount fact
Non-current liabilities 580 580
Total liabilities 1,280 1,280
Total equity plus liabilities 2,380 2,380 Solution:

Required 1- Industry average profit

Which of the following is the correct asset valuation of Transit Co’s equity? 2- Pv of any excess profit us
a $2,380 million
b $1,680 million
c $1,100 million
d $240 million
Revised asset Value=
The value of the net assets $2,380 – $1,280 1,100
: (continuation of Activity 1) CIV

o’s average pre-tax earnings for the last three years has been $400 million, and its
ear end asset base for the last three years has been $2,000 million.
ge (pre-tax) return on tangible assets in this sector has been 12%, corporate income tax
d Transit Co’s weighted average cost of capital is estimated to be 10%.

, calculate the value of Transit Co’s intangible assets:

te the profit that would be expected from an entity’s tangible asset base using an
verage expected return.
ate the present value of any excess profits that have been made in the recent past,
WACC as the discount factor.

$
Industry average profit industry average return x Tangible assets 12% x $2,000 240 $m
Pv of any excess profit using WACC
Pre-tax $400m - $240m 160 $m
Post-Tax 160 X (1-25%) 120 $m
Assuming it is perpetuity PV = 120 / WACC 10% 1200 $m

Revised asset Value= NAV + PV of excess profit $1,100m + $1,200m 2,300 $m

Activity 3: Technique demonstration

Groady plc wants to acquire an Italian company, Bergerbo S.p.A., a company in the same
industry.
BERGERBO S.P.A. SUMMARISED STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDING 31
DECEMBER 20X3
m Euro
PBIT 9.8 9.8
Interest expense 2.3
Taxable profit 7.5
Taxation (25%) 1.9
Profit after tax 5.6
Dividend 5
Retained earnings 0.6

Required
If Groady’s P/E is currently 21.2 and it anticipates turning Bergerbo around so that it shares
Groady’s growth prospects, calculate the value of Bergerbo in €m.

earnings x Acquirer P/E 118.72

Activity 4: Post-acquisition values

Macleanstein Inc is considering making a bid for 100% of Thomasina Inc’s equity capital.
Thomasina has a P/E ratio of 14 and earnings of $500 million.
It is expected that $150 million in annual synergy savings will be made as a result of the takeover
and the P/E ratio of the combined company is estimated to be 16.
Macleanstein currently has a P/E ratio of 17 and earnings of $750 million.
Required
1 - What is the maximum amount that Macleanstein should pay for Thomasina?
2 - What is the minimum bid that Thomasina’s shareholders should be prepared to accept?

Answer:
1- Maximum Bid
Value of Thomasina to Macleanstein = value of combined company – current value of Macleanstein

Combined Group Earning Target Earning + Acquirer Earning + Synergy 500m + 750 + 150
Value of combined company Combined P/E x combined earning 16 x 1,400

Maximum to pay for the targer

Acquirer Current Value Acquirer P/E x Acquirer earning 17 x 750

Max to pay for the target Combined Value - Acquirer Value 22,400 - 12,750

2 minimum Bid

Current market value P/E target x Earning target 14 x 500m

 Calculation of value added by the acquisition

Value added = (Group earnings × new P/E ratio) – value of the bidding company

This is the post-acquisition Value pre-acquisition of

value of the group AND targ

Context example
Using the previous activity:
Current value of Macleanstein $750m × 17
Current value of Thomasina $500m × 14 =
$m Group post-acquisition earnings $750m + $500m + $150m
Macleanstein Value added ($1,400m × 16) - ($12,750m + $7,000m)

500m + 750 + 150 1400

22400

12750

22,400 - 12,750 9650

7000
ue of the bidding company AND the target company

Value pre-acquisition of both the bidder

AND target

$12,750m
$7,000m
$1,400m
$2,650m
Illustration 1: Historic dividend growth

AB Co has just paid a dividend of 40p per share; this has grown from 30p four years ago.
Required
What is the estimated rate of dividend growth?

Solution
30 × (1 + g)^4 = 40
30 × (1 + g)^4 = 40/30 = 1.3333
1 + g = 4th root of 1.3333 = 1.0746
g = 0.0746 or 7.46%

Illustration 2: Reinvestment levels

RS Co has just paid a dividend per share of 30p. This was 60% of earnings per share. Estimated
return on equity = 20%.
Required
What is the estimated rate of dividend growth?

Solution
b = balance of earnings reinvested
b = 1 – 0.6 = 0.4
r = 0.2
g = 0.4 × 0.2 = 0.08 or 8%

Activity 5: Non-constant growth

Hitman Co’s latest dividend was $5 million. It is estimated to have a cost of equity of 8%.

Required
Use the DVM to value Hitman Co, assuming 3% growth for the next three years and 2% growth
after this.

0 1 2 3 4
g 3% 3% 3% 2% Onward
Div 5 5.15 5.3045 5.463635 5.572908
DF @ Ke=8% 0.925926 0.857339 0.793832
PV of future Dividend 4.768519 4.547754 4.33721
Total PV 13.65348

Value calculation for yr 3

P3 = d3 x (1+g) / (Ke - g)
P3 = 92.8818
PV of P3 73.73256

Share Pric 87.38605

245.0627
147.2727
Activity 6: FCF and FCFE method

Wmart Co plans to make a bid for the entire share capital of Ada Co, a company in the same industry.
It is expected that a bid of $75 million for the entire share capital of Ada Co will be successful.
The acquisition will generate the following after-tax operating cash flows (ie pre-interest)
over the next few years by:

Yr 1 2 3 4 and onward
$m 5.6 7.4 8.3 12.1

Both companies have similar gearing levels of 16.7% (debt as a % of total finance).
Ada Co has a $15 million bank loan paying a fixed rate of 5.75%.
Wmart Co has an equity beta of 2.178, the riskfree rate is 5.75% and the market rate is 10%.
Corporation tax is at 30%.

Required
Assess whether the acquisition will enhance shareholder wealth in Wmart Co.
(Use both Approach 1 and Approach 2.)

App 1:
Calculating WACC
Ke (using CAPM) 5.75 + 2.178 (10 – 5.75) 15.01%
Kd* 5.75 x (1 - 30%) 4.03%
D/V 16.70% 0.167
E/V 83.300% 0.833

WACC (15% x 0.833) + (4.03% x 0.167) 13.17%

Yr 1 2 3 4 and onward
$m 5.6 7.4 8.3 12.1
91.85741
5.6 7.4 100.1574
DF @ 13.17% 0.883606 0.78076 0.689884
PV 4.948195 5.777623 69.09702
Total PV 79.82284
Less Debt -15
Value of Equity 64.82284

App 2:
Interest p.a. 15m x 5.75% 0.8625
After tax Interest 0.8625 x (1-30%) 0.60375 m
Yr 1 2 3 4 and onward
$m 5.6 7.4 8.3 12.1
Less Int after Tax -0.60375 -0.60375 -0.60375 -0.60375
4.99625 6.79625 7.69625 11.49625
Perpetuity @ Ke=15% 76.64167
Attributable cash flow to share holders 4.99625 6.79625 84.33792
DF @ Ke =15% 0.869565 0.756144 0.657516
4.344565 5.138941 55.45355
Value of Equity 64.93706
Activity 7: Technique demonstration

Salsa Co plans to make a bid for the entire share capital of Enco Co, a company in a different industry.
It is expected that a bid of £80 million for the entire share capital of Enco Co will be successful.
This will be entirely financed by new debt at 6.8%.
After the acquisition the post-tax operating cash flows of Salsa’s existing business will be:

Time 1 2 3 4 5
£m 24.12 25.57 27.1 28.72 30.45

After the acquisition the post-tax operating cash flows of Enco’s existing business will be:

Time 1 2 3 4 5
£m 6.06 6.3 6.56 6.84 7.13

After the acquisition, £6.5 million of land will be sold and there will be synergies of £5 million post-tax p.a.
Before the acquisition, Salsa had £45 million of debt finance (costing 5.6% pre-tax) and 40 million shares worth £9 each and an
As a consequence of the acquisition, the credit rating of Salsa will fall and the interest paid on existing debt will rise by 1.2% to
Enco has an equity beta of 2.2, its existing share price is £1 and it has 62.4 million shares in issue; it also has £5 million of existi
The risk-free rate is 4.5% and the market rate is 8%; corporation tax is 30%.

Required
Evaluate the impact on shareholder wealth, assuming that cash flows after Year 5 will grow at 2% p.a. (assume that the beta o

Before / stand alone

Salsa Co Enco Co
Be 1.19 2.2
Bd 0 0

Vd 45 $m 5 $m
Ve 360 $m £9 x 40m 62.4 $m £1 x 62.4m

Tax 30% 30%

Ve + Vd(1-T) 391.5 65.9

B asset 1.09425287356322 2.083156

After Acquisition Average asset Beta

Beta Asst 1.24034087936029 (1.09 × 360/422.4) + (2.08 × 62.4/422.4)

Regear to reflect the post acquisition

Ve 422.4

New Debt 80
Existing Debt 50
Total Debt 130

Bd 0
Be 1.50755446842702 1.24/(422.4/(422.4 + 130 × (1 – 0.3)))

V= Vd+Ve 552.4 422 + 130

Rf 4.50%
Rm 8%

Ke 9.78% 4.5 + (1.51 × 3.5)

Kd 6.80% New debt rate is used after the acquisition

WACC 8.60% (9.79 × 422.4/552.4) + (6.8 × 130/552.4 × (1 – 0.3))

Cash Flow

Year 0 1 2 3 4 5

post-tax operating cash flows of Salsa 24.12 25.57 27.1 28.72 30.45
post-tax operating cash flows of Enco 6.06 6.3 6.56 6.84 7.13
Synergy 5 5 5 5 5
Land sold immediately 6.5
Cash flow after acquisition 6.5 35.18 36.87 38.66 40.56
42.58
658.4648
DF @ WACC= 8.6% 1 0.920845 0.847956 0.780836 0.719029 0.662114

6.5 32.39533 31.26413 30.18712 29.16382 464.1719

PV of cash flow 593.6823
Less all Debt 130
Value of Equity 463.6823
Maximum Value to pay 103.6823 Value of combined less value of the bidder

Value created by Acquisition 41.28233

on shares worth £9 each and an equity beta of 1.19.
existing debt will rise by 1.2% to 6.8%.
e; it also has £5 million of existing debt that would be taken over by Salsa Co.

2% p.a. (assume that the beta of debt is zero).

 6

43.4316 =I82*1.02 2% growth