Question

Question 2 Potter plc (Potter) is preparing to make a bid to buy a rival unlisted company, Weasley Ltd (Weasley), which operates in the same business sector. Relevant financial information for both companies is as follows: Potter Weasley PIC £m 46 13 Ordinary share capital (nominal value £1) 7% bonds, redeemable at par in four years' time Potter has an equity beta of 1.2. The risk-free rate of return is 2.5% and the average retum on the market is 7.5%. The 7% bonds are trading at £94 per £100 ex-interest. The ex-div share price of Potter is £2.75 per share and its P/E ratio is 7. Potter believes that its P/E ratio will remain unchanged following the acquisition. The current earnings per share of Weasley is £2.30 and the company maintains a dividend pay-out ratio of 30% every year. Its earnings and hence dividends have grown at an average rate of 3.5% per annum in recent years. Weasley has a cost of equity of 9%. Corporation tax is payable at a rate of 20%. Required (a) Calculate the weighted average cost of capital of Potter Plc. (13 marks) (b) Calculate the value of Weasley Ltd using the following valuation methods: (1) P/E ratio method (ii) Dividend growth model. (6 marks) (c) Discuss the validity of the assumptions that underlie the valuation methods used in part (b), and the suitability of using each method to value the company's shares. (6 marks) (Total 25 marks) TURN OVER

Answer 1

In (b) PIE Ratio and relevent infermation is missing for determination of P/E Ratio. So conclusion i given on the basis of ERS. | Higher the EPS/P/E Ratio , higher the raluation fcanned with CamScanner

b) PLE Ratio Modeli The price - to-eaining vratio RIE Ratio) is the cabin for valuing a company that measures its curren Price earning st is also known as Price multiple or earning multiples. PIE Ratio - on Market Earning Price of share per suam CEPS) Potter plc = 7 - 2.75 EPS EPS 2£0.39280 weasley cita a EPS = £: 2.30 91 can be seen that, wearley Chai's EPS is more in compararion with potte pla. In Lother word, Earnings of shareholder of o calley cuta. is more than potte pla. Dividend grow the model with 588. Potteple potteplc's dividend pay out. Ratio / are . P/E Ratio is les in compararion with I wealey ita. bis higher the ple Ratio EPS will result Scanned with c# higher the Valuation

Calculation of weighted of potter ple. average cost of cofital cost of equity - Risk face jate it bete (Market resund | Risk free ra 32:57: +1.2(7.5 -2.5) = 2.54. + 6.1. = 8.5.4_ | Cost of 7% bonals I + RV-N:P HO R.VtNoP 2 - 7 + 100-94 4 xico 100+g4 127+ X,1%. 7%+1.5.46: 97 7-8.546. Disse consulta weighted Source value weight | Cost of capital / average cost of Coin million) vum Wisatie Equity [£.46 1 77.971 8.5% 1 6.62745.4 71. Bones £ 13 v 22.03% / 8.546% 1.88268% 18. 510. [cs Scanned weighted areage cost of cofital of Pottaple Scanner -8.510 Lutown and