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FM – May 2021 – L3 – Q1 – Business Valuation Techniques

Evaluate the value of Zinco Limited using various valuation techniques and estimate the coupon rate for bond financing.

Palemo Temidayo (PT) is a large engineering company listed on the stock market. The company is considering the purchase of Zinco, an unlisted company that produces a number of engineering components.
The board of directors is concerned about the appropriate price to pay for Zinco. As a starting point, it has been decided to provide a range of valuations based on different industry-recognized techniques.

Summarized financial statements of Zinco Limited for the last two years are shown below:

Statements of Profit or Loss for the years ended 30 June

2020 (N’000) 2019 (N’000)
Sales Revenue 112,400 101,090
Opening Profit before exceptional items 6,510 4,100
Exceptional Items (10,025)
Interest Paid (Net) (1,400) (890)
Profit/(Loss) before Tax (4,915) 3,210
Taxation (1,050) (890)
Profit/(Loss) after Tax (5,965) 2,320
Note: Dividend 1,000 500

Statement of Financial Position as at 31 March (N’000)

Additional Information Relating to Zinco:

  1. If the acquisition succeeds, there will be revenue synergy leading to an increase in annual sales revenue of Zinco of 25% for three years, and 10% per year thereafter.
  2. Non-cash expenses, including depreciation, were N4,100,000 in 2020.
  3. Income tax rate is 30% p.a.
  4. Capital expenditure was N5 million in 2020 and is expected to grow at approximately the same rate as revenue.
  5. Working capital, interest payments, and non-cash expenses are expected to increase at the same rate as revenue.
  6. Zinco has a patent with a current market value of N50 million. This has not been included in the non-current assets.
  7. Operating profit is expected to be approximately 8% of revenue in 2021 and to remain at the same percentage in future years.
  8. Dividends are expected to grow at the same rate as revenue.
  9. The realizable value of inventory is expected to be 70% of its book value.
  10. The estimated cost of equity is 12%.
  11. The average P/E ratio of listed companies of similar size to Zinco is 30:1.
  12. Average earnings growth in the industry is 6% per year.

Required:

a. Prepare a report that gives an estimate of Zinco using:
(i) Asset-based valuation (8 Marks)
(ii) P/E ratios (6 Marks)
(iii) Dividend-based valuation (6 Marks)
(iv) The present value of expected future cash flows (5 Marks)
(v) Discuss the potential accuracy of each of the methods used and recommend, with reasons, a value or range of values that PT might bid for Zinco. State clearly any assumptions that you make.

b. The directors of PT are considering issuing some ₦100 nominal value ten-year bonds to finance the purchase of Zinco. To make the bonds look attractive to potential investors, the bonds are to be issued at a discount of 10%. Based on PT’s credit rating, investors are expected to require a return of 7% per year from such bonds.

You are required:
To estimate the coupon rate that PT will have to pay on these bonds in order to satisfy the investors. (5 Marks)

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FM – May 2021 – L2 – Q2 – Business Valuations

This question covers distinctions between price and value, the subjectivity of valuation, and the valuation of a printing segment using DCF and asset-based methods.

Kwaafi and Sons Ltd operates a newspaper business. The business has various segments, namely: traditional media, online news, events, and printing. The company’s new strategy is to concentrate on online news, outsource its printing services, and discontinue the printing segment.

The printing segment is one of the company’s cash cows, generating 30% of its revenue of GH¢28,000,000 annually. The company aims to take advantage of the Continental Free Trade Agreement to serve other African countries.

Before deciding to concentrate on online news, the company undertook an extensive retooling of its printing segment. The Finance Director has produced the following information:

i) A new coloured printer was purchased to replace a 15-year-old printer, which was purchased for GH¢3,000,000 and is now obsolete but can be sold as scrap for GH¢15,000.

ii) The new coloured printer was purchased two years ago at GH¢8,000,000 and has a useful life of six years.

iii) A contract has been signed for the servicing of the equipment at a retainer fee of GH¢755,250 per annum over the life of the equipment.

iv) The stock of toners and rollers for the old printer worth GH¢280,000 is obsolete at no cost.

v) Replacement parts for the new equipment, which are enough for the useful life of the equipment is valued at GH¢300,000.

vi) Special carbonated toners for the old printer costing GH¢230,000 is unusable and has to be disposed of at a residual value of GH¢13,000 as soon as possible.

vii) Eighteen (18) rolls of printing sheets and twenty-five (25) boxes of metal plates are valued at GH¢240,000 and GH¢420,000, respectively. These need replacement every year at similar costs.

viii) Annual rent and rates of GH¢800,000, payable at the end of each year, increase by 10% every 2 years.

ix) Other operating expenses of GH¢3,200,000, payable at the end of the year, increases at 10% annually until year 3.

x) It is estimated that the printing segment will now generate 10% more revenue per annum for the New Printer’s remaining life. Depreciation is based on the straight-line method.

xi) For valuation purposes, an expected rate of return of 30% has been agreed upon among the parties. Ignore taxation and inflation.

Following the announcement to discontinue the printing segment, the senior staff of the segment proposed to raise funds to buy the assets of the segment. They obtained invoices of similar assets and used the prices to make an offer to the Board of Directors.

The Finance Director disagreed and suggested that an expert valuer value the assets of the company and its operations. The senior staff have objected to the valuation proposals arguing that valuations are subjective and may not reflect the accurate value of the assets to be disposed off by the company.

Required:

a) Distinguish between market price and value in the context of business valuation. (3 marks)

b) Explain why a valuation process is described as subjective. (2 marks)

c) Calculate the value of the printing segment using the discounted cash flow method. (12 marks)

d) Calculate the value of the printing segment using the assets-based method. (3 marks)

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FM – May 2021 – L3 – Q1 – Business Valuation Techniques

Evaluate the value of Zinco Limited using various valuation techniques and estimate the coupon rate for bond financing.

Palemo Temidayo (PT) is a large engineering company listed on the stock market. The company is considering the purchase of Zinco, an unlisted company that produces a number of engineering components.
The board of directors is concerned about the appropriate price to pay for Zinco. As a starting point, it has been decided to provide a range of valuations based on different industry-recognized techniques.

Summarized financial statements of Zinco Limited for the last two years are shown below:

Statements of Profit or Loss for the years ended 30 June

2020 (N’000) 2019 (N’000)
Sales Revenue 112,400 101,090
Opening Profit before exceptional items 6,510 4,100
Exceptional Items (10,025)
Interest Paid (Net) (1,400) (890)
Profit/(Loss) before Tax (4,915) 3,210
Taxation (1,050) (890)
Profit/(Loss) after Tax (5,965) 2,320
Note: Dividend 1,000 500

Statement of Financial Position as at 31 March (N’000)

Additional Information Relating to Zinco:

  1. If the acquisition succeeds, there will be revenue synergy leading to an increase in annual sales revenue of Zinco of 25% for three years, and 10% per year thereafter.
  2. Non-cash expenses, including depreciation, were N4,100,000 in 2020.
  3. Income tax rate is 30% p.a.
  4. Capital expenditure was N5 million in 2020 and is expected to grow at approximately the same rate as revenue.
  5. Working capital, interest payments, and non-cash expenses are expected to increase at the same rate as revenue.
  6. Zinco has a patent with a current market value of N50 million. This has not been included in the non-current assets.
  7. Operating profit is expected to be approximately 8% of revenue in 2021 and to remain at the same percentage in future years.
  8. Dividends are expected to grow at the same rate as revenue.
  9. The realizable value of inventory is expected to be 70% of its book value.
  10. The estimated cost of equity is 12%.
  11. The average P/E ratio of listed companies of similar size to Zinco is 30:1.
  12. Average earnings growth in the industry is 6% per year.

Required:

a. Prepare a report that gives an estimate of Zinco using:
(i) Asset-based valuation (8 Marks)
(ii) P/E ratios (6 Marks)
(iii) Dividend-based valuation (6 Marks)
(iv) The present value of expected future cash flows (5 Marks)
(v) Discuss the potential accuracy of each of the methods used and recommend, with reasons, a value or range of values that PT might bid for Zinco. State clearly any assumptions that you make.

b. The directors of PT are considering issuing some ₦100 nominal value ten-year bonds to finance the purchase of Zinco. To make the bonds look attractive to potential investors, the bonds are to be issued at a discount of 10%. Based on PT’s credit rating, investors are expected to require a return of 7% per year from such bonds.

You are required:
To estimate the coupon rate that PT will have to pay on these bonds in order to satisfy the investors. (5 Marks)

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FM – May 2021 – L2 – Q2 – Business Valuations

This question covers distinctions between price and value, the subjectivity of valuation, and the valuation of a printing segment using DCF and asset-based methods.

Kwaafi and Sons Ltd operates a newspaper business. The business has various segments, namely: traditional media, online news, events, and printing. The company’s new strategy is to concentrate on online news, outsource its printing services, and discontinue the printing segment.

The printing segment is one of the company’s cash cows, generating 30% of its revenue of GH¢28,000,000 annually. The company aims to take advantage of the Continental Free Trade Agreement to serve other African countries.

Before deciding to concentrate on online news, the company undertook an extensive retooling of its printing segment. The Finance Director has produced the following information:

i) A new coloured printer was purchased to replace a 15-year-old printer, which was purchased for GH¢3,000,000 and is now obsolete but can be sold as scrap for GH¢15,000.

ii) The new coloured printer was purchased two years ago at GH¢8,000,000 and has a useful life of six years.

iii) A contract has been signed for the servicing of the equipment at a retainer fee of GH¢755,250 per annum over the life of the equipment.

iv) The stock of toners and rollers for the old printer worth GH¢280,000 is obsolete at no cost.

v) Replacement parts for the new equipment, which are enough for the useful life of the equipment is valued at GH¢300,000.

vi) Special carbonated toners for the old printer costing GH¢230,000 is unusable and has to be disposed of at a residual value of GH¢13,000 as soon as possible.

vii) Eighteen (18) rolls of printing sheets and twenty-five (25) boxes of metal plates are valued at GH¢240,000 and GH¢420,000, respectively. These need replacement every year at similar costs.

viii) Annual rent and rates of GH¢800,000, payable at the end of each year, increase by 10% every 2 years.

ix) Other operating expenses of GH¢3,200,000, payable at the end of the year, increases at 10% annually until year 3.

x) It is estimated that the printing segment will now generate 10% more revenue per annum for the New Printer’s remaining life. Depreciation is based on the straight-line method.

xi) For valuation purposes, an expected rate of return of 30% has been agreed upon among the parties. Ignore taxation and inflation.

Following the announcement to discontinue the printing segment, the senior staff of the segment proposed to raise funds to buy the assets of the segment. They obtained invoices of similar assets and used the prices to make an offer to the Board of Directors.

The Finance Director disagreed and suggested that an expert valuer value the assets of the company and its operations. The senior staff have objected to the valuation proposals arguing that valuations are subjective and may not reflect the accurate value of the assets to be disposed off by the company.

Required:

a) Distinguish between market price and value in the context of business valuation. (3 marks)

b) Explain why a valuation process is described as subjective. (2 marks)

c) Calculate the value of the printing segment using the discounted cash flow method. (12 marks)

d) Calculate the value of the printing segment using the assets-based method. (3 marks)

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