Financial management revision question and answer

Mauzo Ltd. has issued 72,000 ordinary shares as at 31 March 2005. The company had maintained an annual dividend payment of Shs. 180,000 including for the year ended 31 March 2005.

On 3 April 2005, the management of the company identified an investment opportunity which would cost Shs. 720,000. This cost was expected to be financed through an issue of ordinary shares at par. The return on this investment is expected to be 25% per annum on cost over the next four years ending 31 March 2009.

All earnings would continue to be paid out as dividends to shareholders. The cost of capital is 20%.

Required:
(i) Calculate the value of an ordinary share as at 31 March 2005.
(ii) Calculate the value of the company as at 3 April 2005 assuming that the management undertook the investment.
ANSWER

P.V. of new investment: cash flows = 25% x 720,000 = 180,000 (annuity)

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