Question Tag: P/E Ratio

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  • 20 Marks

FM – May 2019 – L3 – Q2 – Strategic Performance Measurement

Calculate and analyze PH Plc.’s financial performance using EPS, dividend yield, dividend cover, and P/E ratio metrics.

The following financial information is available for PH Plc:

Year 2014 2015 2016 2017
Earnings attributed to ordinary shareholders (₦m) 200 225 205 230
Number of ordinary shares (millions) 2,000 2,100 2,100 1,900
Price per share (kobo) 220 305 290 260
Dividend per share (kobo) 5 7 8 8

Assume that share prices are as at the last day of each year.

Required:

a. Calculate PH Plc.’s earnings per share, dividend yield, dividend cover, and price/earnings ratio. Explain the meaning of each term and state their limitations. (14 Marks)
b. Explain why the changes that occurred in the figures calculated in (a) above over the past four years might have happened. (6 Marks)

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  • 40 Marks

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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  • 20 Marks

FM – Nov 2020 – L3 – Q2 – Mergers and Acquisitions

Evaluates the acquisition impact of Yekin plc by Peter John plc, focusing on P/E ratio, EPS, market value, and strategic implications of a hostile takeover versus organic growth.

Peter John plc (PJP) is considering a takeover bid for Yekin plc (YP).

PJP’s board of directors has issued the following statement:
“Our superior P/E ratio and synergistic effects of the acquisition will lead to a post-acquisition increase in earnings per share and in the combined market value of the companies.”

Summarized financial data for the companies (N Million):

PJP YP
Sales 480.0 353.0
Profit before tax 63.0 41.0
Tax (18.9) (12.3)
Profit after tax 44.1 28.7
Dividends 20.0 11.0
Non-current assets (net) 284.0 265.0
Current assets 226.4 173.0
Total assets 510.4 438.0

Equity and Liabilities:

PJP YP
Ordinary shares (10 kobo par value) 40.0 30.0
Reserves 211.2 192.0
Medium and long-term borrowing 86.0 114.0
Current liabilities 173.2 102.0
Total 510.4 438.0

Notes:

  1. After-tax savings in cash operating costs of N7,500,000 per year indefinitely are expected as a result of the acquisition.
  2. Initial redundancy costs will be ₦10 million before tax.
  3. PJP’s cost of capital is 12%.
  4. Current share prices: PJP = N29, YP = N18.
  5. The proposed terms of the takeover are payment of 2 PJP shares for every 3 YP shares.

Required:

a. Calculate the current P/E ratios of PJP and YP. (2 Marks)
b. Estimate the expected post-acquisition earnings per share and comment upon the importance of increasing the earnings per share. (4 Marks)
c. Estimate the effect on the combined market value as a result of the takeover using:
i. P/E-based valuation
ii. Cash flow-based valuation
State clearly any assumptions that you make. (5 Marks)
d. Discuss the limitations of your estimates in (c) above. (3 Marks)
e. Evaluate the strategic implications of making a hostile bid for a company compared with an aggressive investment program of organic growth. (6 Marks)

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  • 20 Marks

FM – Nov 2018 – L3 – Q3 – Business Valuation Techniques

Valuation of acquisition target using free cash flow forecast and P/E ratio analysis in the context of an acquisition.

Lagelu Plc. (LP) is a very successful entity. The company has consistently followed a business strategy of aggressive acquisitions, looking to buy companies that it believes were poorly managed and hence undervalued. LP can be described as a modern-day conglomerate with business interests stretching far and wide.

Its board of directors has chosen the takeover targets with care. LP has maintained its price earnings (P/E) ratio on the stock market at 12.2.

LP’s figures show a profit after tax of ₦4,430 million, and it has 375 million shares.

Lam Technical (LT) is a well-established owner-managed business. It has had its ups and downs in financial terms, corresponding directly with the state of the global economy. Since 2001, its profits have fallen each year, with the 2017 results as stated below:

With economists predicting an upturn in the global economy, LT’s management team feels that revenue will increase by 6% per annum up to and including year 2021. The company’s operating profit margin is not expected to change in the foreseeable future.

Operating profits are shown after deducting non-cash expenses (including tax-allowable depreciation) of ₦650m. This is expected to increase in line with sales. However, the company has recently spent ₦1,050m on the purchase of non-current assets, and LT’s management believes this will need to increase by 10% per annum until year 2021 to enable the company to remain competitive.

LT is currently financed by debt and equity. It has maintained a constant debt-to-total-asset ratio of 40% and has no intention to change this financing mix in the near future.

The company has a cost of equity of 17% and a weighted average cost of capital of 12%.

Assume a tax rate of 25% in all cases.

Some of LT’s major shareholders are not so confident about the future and would like to sell the business as a going concern. The minimum price they would consider would be the fair value of the shares plus a 10% premium. LT’s Chief Financial Officer believes the best way to find the fair value of the shares is to discount the forecast Free Cash Flows to the firm, assuming that beyond the year 2021, these will grow at a rate of 3% per annum indefinitely.

Required:

a. Prepare a schedule of forecast Free Cash Flows to the firm for each of the years from December 31, 2018, to 2021. (5 Marks)

b. Estimate the fair value of LT’s equity on a per-share basis. (6 Marks)

c. LP intends to make an offer to LT based on a share-for-share swap. LP will exchange one of its shares for every two LT shares. Assuming that LP can maintain its price earnings (P/E) ratio of 12.2, calculate the percentage gain in equity value that will be earned by both groups of shareholders. (6 Marks)

d. What factors should the LT shareholders consider before deciding whether to accept or reject the offer made by LP? (3 Marks)

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  • 15 Marks

FM – Nov 2022 – L3 – Q6 – Dividend Policy

Analyze P/E ratios and calculate dividend cover for companies in the food retail sector.

Companies A, B, and C are in the food retailing sector of the stock market. The following key stock market statistics are provided.

Food Retailers: Ordinary Shares, Key Stock Market Statistics:

Company A B C
Share Price (₦) 2.10 1.80 2.30
Earnings per Share (₦) 0.30 0.25 0.35
Dividend per Share (₦) 0.18 0.15 0.25

Required:

a. Illustrating your answer by using data from the table above, define and explain the term P/E ratio, and comment on the way it may be used by an investor to appraise a possible share purchase. (8 Marks)

b. Using data in the above table, calculate the dividend cover for Companies C and B, and explain the meaning and significance of the measure from the point of view of equity investors. (7 Marks)

(Total 15 Marks)

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  • 20 Marks

FR – Aug 2022 – L2 – Q4 – Financial Statement Analysis

Calculate various financial ratios for Pat Plc and compare them to industry averages and Write a report to assess the financial performance and position of Pat Plc relative to industry standards based on the calculated ratios.

Pat Plc is a listed Ghanaian company that produces textile prints for local and African markets. During the year ended 31 March 2022, the following financial information was available:

Gross profit: GH¢12,150
Cost of sales: GH¢77,850
Operating profit before interest and tax: GH¢7,130
Finance cost: GH¢920
Tax charged to profit or loss: GH¢1,400
Inventory turnover: 3.6 times
Dividend per share: GH¢0.36
Dividend yield: 6%

Extracts from the Statement of Financial Position as at 31 March 2022:

Required:
a. Based on the information provided, compute the following ratios for Pat Plc:
i) Profit (after tax) margin
ii) Current ratio
iii) Return on Capital Employed (ROCE)
iv) Receivables period
v) Price/Earnings ratio
vi) Debt/Equity ratio

b. Using the ratios computed in Question 4a, write a report to the Board of Directors of Pat Plc assessing the financial performance and financial position of the entity, relative to its industry.

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  • 14 Marks

AFM – Nov 2016 – L3 – Q1b – Business reorganisation | Valuation of acquisitions and mergers

Calculate and analyze the effects of a proposed spin-off on shareholder wealth and discuss reasons and disadvantages of a spin-off.

Last Chance Limited operates various manufacturing and retail operations throughout Ghana and has 400 million GH¢0.25 ordinary shares in issue. For the year that has just ended, the directors reported total after-tax profits of GH¢300 million and the P/E ratio of the company is 11.4 times.

The company has developed sophisticated computer software over the years and now considers ‘spinning-off’ its subsidiary, Ananse Systems Limited. Ananse Systems Limited has contributed GH¢40 million of the total after-tax profits of Last Chance Limited. After the spin-off, Last Chance Limited’s P/E ratio is expected to reduce to 11.0 times, while Ananse Systems Limited is expected to attract a P/E ratio of either 17 or 18 times.

Required:
i) Suggest THREE reasons why Last Chance Limited may wish to ‘spin-off’ part of its operations. (3 marks)
ii) Discuss THREE possible disadvantages of a ‘spin-off’ for the shareholders of Last Chance Limited. (3 marks)
iii) Calculate the likely effect of the proposed ‘spin-off’ on the wealth of a shareholder holding 10,000 ordinary shares in Last Chance, assuming that Ananse Systems Limited trades at a P/E ratio of 17 times and 18 times. (8 marks)
(Ignore taxation)

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  • 15 Marks

CR – Nov 2023 – L3 – Q4a – Business Valuation

Determine appropriate valuation methods and price range for Odenkey Plc based on financial statements and additional information provided.

a) The Directors of Odenkey Plc have decided to sell their business and have begun a search for organisations interested in the purchase. As a Consultant, you have been asked to determine the appropriate range of price per share suitable for the company. Relevant information is as follows:

Additional information:

  1. The receivables include GH¢12,000,000 of revenue for credit sales made on a ‘sale or return’ basis. On 31 December 2022, customers who had not paid for the goods, had the right to return GH¢5,000,000 worth of them. Odenkey Plc applied a markup on cost of 25% on all these sales. Based on previous transactions, it is expected that 80% of the goods will be returned.
  2. The property, plant and equipment includes a building that was originally acquired for GH¢20,000,000 five years ago with an initial estimated useful life of 20 years. The property was revalued to GH¢18,000,000 as at 31 December 2022, and the revaluation reserve is yet to be recognised in the financial statement. Due to degradation of the land on which the building stands, the company undertook an impairment review and it was found that, the fair value of the property as at 31 December 2022 is estimated to be GH¢17,000,000. The value in use of the property is calculated as being GH¢16,000,000.
  3. The patent was originally acquired 2 years ago and the rights were set at 50 years from the date the patent was originally purchased. The patent was amortised by Odenkey Plc using straight line method over the remaining copyright period. However, recent legislative changes passed on 1 January 2022 have extended the patent period forever. The Research and Development departments projects net future cashflow of GH¢4,500,000 per year from the patent even though the prices of similar patents on the market are valued at GH¢ 18,500,000.
  4. The company had a retained earnings balance of GH¢5,000,000 as at 31 December 2021. It has always practiced a dividend payout ratio of 35% when it makes profit during the year.
  5. The following information relates to Odenkey Plc and a competitor Odafomtim Ltd: Odenkey Plc Odafomtim Ltd Number of Shares 3,000,000 500,000 5 years’ average sales growth 8% 9% 5 years’ average growth in EBIT 6% 10.5% P/E ratio as at 31 December 2022 – 18.61 Estimated return on equity 9.5% 12%
  6. The company’s cost of capital is 25%.
  7. Odafomtim Ltd is a listed firm and has a sizeable market share.

Required:

i) Use the information provided to suggest FOUR (4) valuations which prospective purchasers might make.

(12 marks)

ii) Comment on the appropriateness of the range of price per share of Odenkey Plc that the Directors can offer.

(3 marks)

 

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  • 20 Marks

FM – Nov 2020 – L2 – Q2 – Business valuations

Estimate the value of equity capital using different valuation methods: Book value, Replacement cost, Realizable value, Gordon growth model, and P/E ratio model.

The directors of Carmen Ltd, a large conglomerate, are considering the acquisition of the entire share capital of Manon Ltd, a private limited company that manufactures a range of engineering machinery. Neither company has any long-term debt capital. The directors of Carmen Ltd believe that if Manon Ltd is taken over, the business risk of Carmen Ltd will not be affected.

The accounting year of Manon Ltd ends on 31 December. Its Statement of Financial Position as at 31 December 2018 is expected to be as follows:

Manon Ltd’s summarized statement of profit or loss extract for the five years to 31 December 2018 is as follows:

The following additional information is available:

i) There have been no changes in the issued share capital of Manon Ltd during the past five years.
ii) The estimated values of Manon Ltd’s PPE and inventory and work-in-progress as at 31 December 2018 are:

Replacement cost (GH¢) Realizable value (GH¢)
PPE 725,000 450,000
Inventory and work-in-progress 550,000 570,000

iii) It is expected that 2% of Manon’s debtors at 31 December 2018 will be uncollectible.
iv) The cost of capital of Carmen Ltd is 9%. The directors of Manon Ltd estimate that the shareholders of Manon Ltd require a minimum return of 12% per annum from their investment in the company.
v) The current P/E ratio of Carmen Ltd is 12. Quoted companies with business activities and profitability similar to those of Manon Ltd have P/E ratios of approximately 10, although these companies tend to be much larger than that of Manon Ltd.

Required:

Estimate the value of the total equity capital of Manon Ltd as at 31 December 2018 using each of the following bases:

a) Book value (2 marks)
b) Replacement cost (4 marks)
c) Realizable value (4 marks)
d) The Gordon dividend growth model (5 marks)
e) The P/E ratio model (5 marks)

 

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  • 20 Marks

FM – Nov 2023 – L2 – Q2 – Business valuations | Mergers and acquisitions

Evaluate the potential acquisition of Akwaaba Films by Lekker Inc, including valuation, cost of equity, and reasons for potential merger failures.

Lekker Inc (Lekker) is a film company located in South Africa. The company is planning to expand into other African countries. The research department of Lekker recommends Ghana as a good location for establishing a subsidiary due to its abundant talent and political stability. However, the company is unsure whether to establish a completely new subsidiary or acquire an existing film company in Ghana. You have been engaged as a consultant to guide Lekker in taking this decision.

Your preliminary assessment revealed the following:

i) You have identified a Ghanaian filmmaker who owns a fast-growing film company called Akwaaba Films (Akwaaba). You observed that the Ghanaian filmmaker is likely to sell Akwaaba if Lekker could pay GH¢450,000 as purchase consideration. Akwaaba is entirely self-financed, with the owner receiving all profits as dividends. You forecast that Akwaaba’s profit after tax will grow at a rate of 6% per year for the first two years, 4% per year for the next two years, and thereafter, grow at a constant rate of 2% per year in perpetuity. The financial information extracted from Akwaaba shows the following:

Description GH¢
Revenue 250,000
Operating Cost (140,000)
Administrative cost (30,000)
Profit before tax 80,000
Tax @ 25% (20,000)
Profit after tax 60,000

ii) If Lekker decides to set up the subsidiary in Ghana by itself with the same GH¢450,000 purchase consideration for Akwaaba, its after-tax cash flows will be as follows:

Year Cash Flow (GH¢)
Year 1 15,000
Year 2 26,000
Year 3 35,000
Year 4 33,000

The overall Price/Earnings (P/E) ratio for the film industry in Ghana is 15 times. The average cash flow risk for unquoted companies in Ghana is 20%. Lekker does not intend to list on the Ghana Stock Exchange.

iii) Lekker’s cost of capital is 16%.

Required:
a) Enumerate THREE (3) advantages of expansion through acquisition over organic expansion to the owners of Lekker. (6 marks)
b) Compute the value of Akwaaba using the dividend valuation method and advise Lekker whether it should acquire Akwaaba at the purchase consideration of GH¢450,000. (8 marks)
c) Using the P/E ratio method, estimate the expected value of Lekker’s subsidiary in Ghana without the acquisition. (4 marks)
d) State TWO (2) reasons mergers and acquisitions may fail to achieve the expected outcomes. (2 marks)

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  • 12 Marks

FM – Nov 2017 – L2 – Q5a – Business valuations

Estimate the value per share of LHW Ltd using different valuation methods including net asset value, P/E ratio, and dividend yield basis.

Paul and Tony Reid are the owners of LHW Ltd., publishers of “Luxury Homes of the World”. As with similar publishers, they are currently experiencing difficult market conditions. Paul wishes to sell his share of the business to Tony to pursue other interests. Paul feels their business has a “long term value” not captured by current market values. Paul and Tony wish to have their business “properly valued” so a “fair” buyout price can be agreed.

LHW Ltd: Balance Sheet as at 31 December 2016

Net profit after tax and interest payments but before dividends was GH¢250,000, and the annual dividend was GH¢100,000 for the year ended December 31, 2016.

Covenants in the debentures require that a change in ownership of LHW would result in the redeeming of its debentures. They must be redeemed at “fair market value” based on the yield on comparable bonds, which is currently 8% p.a. The semi-annual coupon has just been paid with 10 more due before the bond would mature in 2022.

Paul and Tony estimate that 20% of LHW’s debtors are likely to be irrecoverable, but feel that current market conditions will improve and that over the next three years, earnings should increase by 5% per annum.

Independent valuations state that the current realizable values of the company’s fixed assets are:

Fixed Asset Realisable Value (GH¢ million)
Land and Buildings 2.0
Plant and Machinery 4.0
Fixtures and Fittings 1.2
Motor Vehicles 0.35
Total 7.55

For a firm similar to LHW Ltd with similar growth expectations but which is quoted on the stock exchange, the Price Earnings (P/E) ratio was 14 times, and its gross dividend yield was 10%.

Required:
a) Given the above information, estimate the value per share of LHW Ltd using:
i) The net asset (liquidation) basis
ii) The P/E basis
iii) The dividend yield basis (assume with no growth)
iv) The dividend yield basis (assume with growth) (12 marks)

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  • 15 Marks

FM – MAY 2018 – L2 – Q5 – Business valuations

Explains the degrees of stock market efficiency and involves calculating the value of a company based on expected earnings and discussing the limitations of using the P/E method for valuation.

a) The directors of Clear Tel Ltd, a private telecommunication company, are considering a proposed resolution for converting the company to a public company and listing its equity stock on the stock exchange. The directors expect that the stock market listing can enhance Clear Tel’s ability to raise large amounts of capital from the public. However, they fear that stock market inefficiencies could have a negative effect on the price of Clear Tel’s equity stock.

Required:

Explain the THREE degrees of stock market efficiency, and how the price of Clear Tel is expected to move in each case.
(6 marks)

b) Restwell Ltd, a hotel leisure company, is currently considering taking over a smaller private limited company, Staygood Ltd. The board of Restwell is in the process of making a bid for Staygood, but first needs to place a value on the company. Restwell has gathered the following data:

The company’s earnings yield is 12%.

Required:

i) As a Finance Manager, calculate the value of the company based on the present value of expected earnings.
(6 marks)

ii) Explain THREE problems associated with using the P/E method for valuing firms.
(3 marks)

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  • 15 Marks

FM – NOV 2018 – L2 – Q5 – Business valuations

Involves calculating a range of valuations for an unquoted company using earnings and P/E ratios, and calculating the market value of bonds based on the cost of debt

a) Flue Ltd wishes to make a takeover bid for the shares of Donc Ltd, an unquoted company. The earnings of Donc Ltd over the past five years have been as follows:

Year Earnings (GH¢)
2013 40,000
2014 57,600
2015 54,400
2016 56,800
2017 60,000

The average P/E ratio of quoted companies in the industry in which Donc Ltd operates is 10. Quoted companies that are similar in many respects to Donc Ltd are:

  • Beans Ltd has a P/E ratio of 15 but is a company with very good growth prospects.
  • Wash Ltd has had a poor profit record for several years and has a P/E ratio of 7.

Required:

Calculate a suitable range of valuations for the shares of Donc Ltd.
(9 marks)

b) Food Ltd has in issue 12% bonds with a par value of GH¢150,000 and a redemption value of GH¢165,000, with interest payable quarterly. The cost of debt on the bonds is 8% annually and 2% quarterly. The bonds are redeemable on 30 June 2021, and it is now 31 December 2017.

Required:

Calculate the market value of the bonds.
(6 marks)

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