- 30 Marks
Question
You are employed by Bolade Plc ( BP), a very large printing firm with retail outlets across Nigeria. Its board is considering making an offer to buy 100% of the shares of Kenny Ltd (KL), a competitor of Bolade in Aba. KL‟s financial year end is 28 February and its most recent financial statements are summarised below:
KL Income Statement for the year ended 28 February 2023
| ₦m | |
|---|---|
| Revenue | 17.3 |
| Profit before interest and tax | 5.9 |
| Interest | (0.3) |
| Profit before taxation | 5.6 |
| Tax at 21% | (1.2) |
| Profit after taxation | 4.4 |
| Dividends declared | 1.1 |
KL Statement of financial position at 28 February 2023
| ₦m | ₦m | ₦m | |
|---|---|---|---|
| Non-current assets: | |||
| Freehold land and buildings (original cost ₦4.1m) | 3.5 | ||
| Machinery (original cost ₦8.8m) | 5.3 | ||
| 8.8 | |||
| Current assets: | |||
| Inventories | 3.0 | ||
| Receivables | 0.5 | ||
| Cash and bank | 2.8 | ||
| 6.3 | |||
| Current liabilities: | |||
| Trade payables | 3.5 | ||
| Dividends | 1.1 | ||
| Taxation | 1.2 | ||
| (5.8) | |||
| 0.5 | |||
| 9.3 | |||
| Non-current liabilities: | |||
| 10% bonds (redeemable 2031) | (3.0) | ||
| 6.3 | |||
| Equity: | |||
| Ordinary shares of ₦1 each | 2.1 | ||
| Retained earnings | 4.2 | ||
| 6.3 |
Additional Information KL‟s management had some of the company’s assets independently revalued in January 2023. Those values are shown below:
| ₦m | |
|---|---|
| Freehold land and building | 8.3 |
| Machinery | 4.1 |
| Inventories | 3.1 |
The average price/earnings ratio for listed business in the printing industry is 9 and the average dividend yield is 6% p.a.
The cost of equity of business in the printing industry, taking account of the industry average level of capital gearing, is 14% p.a.
KL’s finance department has estimated that the company’s pre-tax net cash inflows (after interest) for the next four trading years ending 28 February, before taking account of capital allowances, will be:
| ₦m | |
|---|---|
| Year to 2024 | 4.6 |
| Year to 2025 | 4.3 |
| Year to 2026 | 5.2 |
| Year to 2027 | 5.7 |
KL’s existing equipment has tax written-down value of ₦3.6 million at 28 February 2023. The equipment attracts 18% (reducing balance) tax allowances in every year of ownership by the company, except the final year.
You should assume that KL will not be purchasing or disposing of any machinery in the years 2024-2027 and that it would dispose of the existing equipment on 28 February 2027 at its tax written-down value.
Bolade’s board estimates that in four years‟ time, i.e. 28 February 2027, it could, if necessary, dispose of KL for an amount equal to four times its after-tax cash flow (ignoring the effects of capital allowances and the disposal value of the equipment) for the year to 28 February 2027.
Assume that the company income rate is 21% p.a.
Required: Using the information provided, prepare a report for Bolade’s board by:
a. Calculating the value of one share in KL based on each of the following
methods:
i. Net asset basis (historic cost)
ii. Net asset basis (revalued)
iii. Price/earnings ratio
iv. Dividend yield
v. Present value of future cash flows
(16 Marks)
b. Explain the advantages and disadvantages of using each of the five valuation methods in (a). (8 Marks)
c. What are the possible benefits from the merger between Bolade Plc (BP) and Kenny Limited (KL). (6 Marks)
Answer
a. Report on Valuation of Kenny Ltd (KL)
i. Net asset basis (historic cost)
Net assets (equity) = ₦6.3m
Number of shares = 2.1m
Value per share = 6.3 / 2.1 = ₦3.00
ii. Net asset basis (revalued)
Revalued non-current assets = 8.3 + 4.1 = ₦12.4m
Revalued current assets = (3.1 + 0.5 + 2.8) = ₦6.4m
Total revalued assets = ₦18.8m
Less liabilities = 5.8 + 3.0 = ₦8.8m
Revalued net assets = ₦10.0m
Value per share = 10.0 / 2.1 = ₦4.76
iii. Price/earnings ratio
EPS = 4.4 / 2.1 = ₦2.10
Value per share = 9 × 2.10 = ₦18.90
iv. Dividend yield
DPS = 1.1 / 2.1 = ₦0.52
Value per share = 0.52 / 0.06 = ₦8.73
v. Present value of future cash flows
Capital allowances:
Year 2024: 0.18 × 3.6 = 0.65, TWDV = 2.95
Year 2025: 0.18 × 2.95 = 0.53, TWDV = 2.42
Year 2026: 0.18 × 2.42 = 0.44, TWDV = 1.98
Year 2027: Nil
After-tax cash flows:
2024: Taxable profit = 4.6 – 0.65 = 3.95, Tax = 0.83, AT CF = 3.77
2025: 4.3 – 0.53 = 3.77, Tax = 0.79, AT CF = 3.51
2026: 5.2 – 0.44 = 4.76, Tax = 1.00, AT CF = 4.20
2027: 5.7 – 0 = 5.7, Tax = 1.20, AT CF = 4.50
Terminal value = 4 × 4.50 = 18.00
Total 2027 CF = 4.50 + 18.00 = 22.50
PV at 14%:
PV 2024 = 3.77 / 1.14 = 3.31
PV 2025 = 3.51 / 1.14² = 2.70
PV 2026 = 4.20 / 1.14³ = 2.83
PV 2027 = 22.50 / 1.14⁴ = 13.33
Total PV = 22.17m
Value per share = 22.17 / 2.1 = ₦10.56
(16 Marks)
b. Advantages and disadvantages
Net asset basis (historic cost):
Advantages: Simple to calculate; objective.
Disadvantages: Based on historic costs; ignores future earnings potential.
Net asset basis (revalued):
Advantages: Reflects current market values; more relevant.
Disadvantages: Subjective valuations; not all assets may be revalued.
Price/earnings ratio:
Advantages: Incorporates market expectations; easy to apply.
Disadvantages: Relies on comparable companies; backward-looking earnings.
Dividend yield:
Advantages: Focuses on cash returns to shareholders; simple.
Disadvantages: Ignores growth opportunities; unsuitable for low dividend companies.
Present value of future cash flows:
Advantages: Forward-looking; considers time value of money.
Disadvantages: Sensitive to assumptions (e.g., discount rate, forecasts); complex.
(8 Marks)
c. Possible benefits from the merger
- Economies of scale in production and purchasing.
- Increased market share and bargaining power.
- Synergies in distribution and retail outlets.
- Cost savings from shared resources.
- Diversification of risk.
- Enhanced competitive position in the printing industry.
(6 Marks)
- Tags: Acquisitions, Business Valuation, Discounted Cash Flow, Dividend Yield, Mergers, Net Asset Value, P/E Ratio, Synergies
- Level: Level 3
- Topic: Business Valuation Techniques
- Series: MAY 2024
- Uploader: Samuel Duah