acca past paper f9 2007
Answers
Fundamentals Level – Skills Module, Paper F9
Financial Management
1
(a)
December 2007 Answers
(i)
Price/earnings ratio method valuation
Earnings per share of Danoca Co = 40c
Average sector price/earnings ratio = 10
Implied value of ordinary share of Danoca Co = 40 x 10 = $4·00
Number of ordinary shares = 5 million
Value of Danoca Co = 4·00 x 5m = $20 million
(ii)
Dividend growth model
Earnings per share of Danoca Co = 40c
Proposed payout ratio = 60%
Proposed dividend of Danoca Co is therefore = 40 x 0·6 = 24c per share
If the future dividend growth rate is expected to continue the historical trend in dividends per share, the historic dividend growth rate can be used as a substitute for the expected future dividend growth rate in the dividend growth model.
Average geometric dividend growth rate over the last two years = (24/ 22)1/2 = 1·045 or 4·5%
(Alternatively, dividend growth rates over the last two years were 3% (24/23·3) and 6% (23·3/22), with an arithmetic average of (6 + 3)/2 = 4·5%)
Cost of equity of Danoca Co using the capital asset pricing model (CAPM)
= 4·6 + 1·4 x (10·6 – 4·6) = 4·6 + (1·4 x 6) = 13%
Value of ordinary share from dividend growth model = (24 x 1·045)/(0·13 – 0·045) = $2·95
Value of Danoca Co = 2·95 x 5m = $14·75 million
The current market capitalisation of Danoca Co is $16·5m ($3·30 x 5m).The price/earnings ratio value of Danoca Co is higher than this at $20m, using the average price/earnings ratio used for the sector. Danoca’s own price/earnings ratio is 8·25. The difference between the two price/earnings ratios may indicate that there is scope for improving the financial performance of Danoca Co following the acquisition. If Phobis Co has the managerial skills to effect this improvement, the company and its shareholders may be able to benefit as a result of the acquisition.
The dividend growth model value is lower than the current market capitalisation at $14·75m. This represents a
Fundamentals Level – Skills Module, Paper F9
Financial Management
1
(a)
December 2007 Answers
(i)
Price/earnings ratio method valuation
Earnings per share of Danoca Co = 40c
Average sector price/earnings ratio = 10
Implied value of ordinary share of Danoca Co = 40 x 10 = $4·00
Number of ordinary shares = 5 million
Value of Danoca Co = 4·00 x 5m = $20 million
(ii)
Dividend growth model
Earnings per share of Danoca Co = 40c
Proposed payout ratio = 60%
Proposed dividend of Danoca Co is therefore = 40 x 0·6 = 24c per share
If the future dividend growth rate is expected to continue the historical trend in dividends per share, the historic dividend growth rate can be used as a substitute for the expected future dividend growth rate in the dividend growth model.
Average geometric dividend growth rate over the last two years = (24/ 22)1/2 = 1·045 or 4·5%
(Alternatively, dividend growth rates over the last two years were 3% (24/23·3) and 6% (23·3/22), with an arithmetic average of (6 + 3)/2 = 4·5%)
Cost of equity of Danoca Co using the capital asset pricing model (CAPM)
= 4·6 + 1·4 x (10·6 – 4·6) = 4·6 + (1·4 x 6) = 13%
Value of ordinary share from dividend growth model = (24 x 1·045)/(0·13 – 0·045) = $2·95
Value of Danoca Co = 2·95 x 5m = $14·75 million
The current market capitalisation of Danoca Co is $16·5m ($3·30 x 5m).The price/earnings ratio value of Danoca Co is higher than this at $20m, using the average price/earnings ratio used for the sector. Danoca’s own price/earnings ratio is 8·25. The difference between the two price/earnings ratios may indicate that there is scope for improving the financial performance of Danoca Co following the acquisition. If Phobis Co has the managerial skills to effect this improvement, the company and its shareholders may be able to benefit as a result of the acquisition.
The dividend growth model value is lower than the current market capitalisation at $14·75m. This represents a