Solved: The managing directors of Wrack plc are

considering what value

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

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 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.

The managing directors of Wrack plc are considering what value

ANSWER
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