Financial management revision question & answer

Love Ltd is considering acquiring Beautiful Ltd. For the past six years, the profits of Beautiful Ltd. has been as follows:

Year 1996 1997 1998 1999 2000 2001
Profits Sh.‟M‟ 85 93 107 113 113 119

Love Ltd expects to pay a DPS of Sh.3.20. The current MPS is Sh.40. The growth in dividends will be matched with the growth in earnings of Beautiful Ltd. once acquired. The future expected profits p.a. (equal to the average of past profits) will also grow a rate equal to past profits growth rate. Love Ltd is an all equity firm. Beautiful Ltd has 50 million ordinary shares.

Required:
a) Compute the cost of equity of Love Ltd.

b) Using the cost of equity computed in (a) above, determine the maximum price with Love Ltd should pay for each share of Beautiful Ltd to acquire it.
c) What is the significance of valuation of securities.
ANSWER
a) Compute growth

Significance of valuation of securities
– for mergers and acquisitions
– Using a share as a security for a loan
– liquidation of a firm
– getting quoted on NSE
– Sale of a firm as a going concern
– Sale of a subsidiary to a MBO team or 3rd party.

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