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Question 3a iii

Recent financial information relating to Close Co, a stock market listed company, is as follows.

$m
profit after tax (earnings)66.6
dividends40.0
statement of financial position information
$m$m
non current assets595
current assets125
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total assets720
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current liabilities70
equity
ordinary shares ($1 nominal)80
reserves410
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490
non current liabilities
6% bank loan40
8% bonds ($100 nominal)120
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160
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720
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Financial analysts have forecast that the dividends of Close Co will grow in the future at a rate of 4% per year. This is slightly less than the forecast growth rate of the profit after tax (earnings) of the company, which is 5% per year.

The finance director of Close Co thinks that, considering the risk associated with expected earnings growth, an earnings yield of 11% per year can be used for valuation purposes.

Close Co has a cost of equity of 10% per year and a before-tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal value in six years’ time. Close Co pays tax at an annual rate of 30% per year and the ex-dividend share price of the company is $8·50 per share.

Required:

Calculate the value of Close Co using the earnings yield method

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