Reference no: EM133121565
Question 1:
A UK Company trading on London Stock Exchange has the following information as of the end of 2021.
Net debt: £25
Tax rate: 20%
Interest paid: £89
Interest received:£82
Total assets: £300
Total liabilities: £210
Variance of returns on London Stock Exchange:0.6
The covariance of the company's stock returns with the returns of London Stock Exchange:0.98
Expected Market Return: 12%
UK Government Bond Yield: 1.4%
The company's actual Book Value and its forecasted earnings and dividends as well their actual and forecasted numbers of shares are given below. The expected growth in residual earnings is 1% per annum after 2025.
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2021 A
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2022 F
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2023 F
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2024 F
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2025 F
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Earnings
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£85
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£90
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£282
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£240
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Dividends
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£50
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£27
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£100
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£55
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Book value
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£360
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Number of shares
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100
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120
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120
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200
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200
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A=Actual; F=Forecasted
a) Using the abnormal earnings model, estimate the value for each share of this company.
b) Company's shares are traded at £4. As an analyst what would be your recommendation to investors about this company based on your abnormal earnings model analysis. Why?
c) Another analyst approaches you and shows that by using the discounted free cash flows valuation model, she calculated a different value and thus has reached to a different recommendation than the one you reached in part (b) above. You check her calculations and conclude that they are correct, and her assumptions are sound. You are also confident about your calculations and assumptions.
i. Would you change your recommendation in (b) according to this new recommendation? Why? Why not?
ii. Would your answer have changed if the company in question had been a new start up with no positive cash flows forecasted in the short term? Why/Why not?