The following extract from the management accounts of a family run business, prepared on a

historical convention is available:

STATEMENT OF INCOME

Historical

Historical Historical Year 3

Year 1 Year 2 (most recent)

Turnover 2 000 000 1 800 000 2 100 000

Cost of sales 1 110 000 1 160 000 1 180 000

Gross profit 890 000 640 000 920 000

Sales of assets - 120 000 -

Depreciation (50 000) (50 000) (50 000)

Interest (200 000) (200 000) (200 000)

Other expenses (270 000) (300 000) (280 000)

Investment income 80 000 120 000 120 000

Foreign exchange loss (150 000) - -

Earnings before tax 300 000 330 000 510 000

The following information is also available:

 The foreign exchange loss occurred as no forward cover was taken on exports. It is now
company policy to take out forward cover.
 In Year 2, the company incurred legal costs of R50 000 as a result of contesting an unfair
dismissal case.
 Mr I Jones holds 70% of the shares in the company. He manages the company and
receives an annual salary of R80 000. If the company employed a suitably qualified
manager, the annual cost would be R200 000.
 The assets of the company are old and need to be replaced to sustain the business. Asset
replacement would result in increased depreciation of R100 000 per annum if operations
are to be sustained at historical levels, but would have to increase by R125 000 to
facilitate the forecasted figures.
 The forecast above was prepared by Mr Jones, based on indications of strong demand for
the company’s products. Specific industry information is not available, but the current
order book has grown compared to a year ago. Discussions with Mr Jones indicate that
the company has obtained new contracts, thereby slightly increasing its market share, but
the overall market seems to have grown in line with the economy. Mr Jones views the
increased sales as sustainable.

Required:
Determine the maintainable earnings for the purpose of a fair market valuation, using a
P/E multiple method. Mention and discuss the matters of contention.