Question 3a iii
You will get this Formula Table at the exam so learn well how to apply it in your FM (F9) Exam
Recent financial information relating to Close Co, a stock market listed company, is as follows.
$m | ||
profit after tax (earnings) | 66.6 | |
dividends | 40.0 | |
statement of financial position information | ||
$m | $m | |
non current assets | 595 | |
current assets | 125 | |
------- | ||
total assets | 720 | |
------- | ||
current liabilities | 70 | |
equity | ||
ordinary shares ($1 nominal) | 80 | |
reserves | 410 | |
------- | ||
490 | ||
non current liabilities | ||
6% bank loan | 40 | |
8% bonds ($100 nominal) | 120 | |
------- | ||
160 | ||
------- | ||
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