Reference no: EM132919213
Question - Soulking plc is planning the acquisition of Rapstar plc, for which purpose it is attempting to value the target company. The income statement of Rapstar plc for the year ended 30th September 2015 is summarised below: £ millions Turnover 300.00 Less: Operating costs 273.00 Operating profit 27.00 Less: Tax (26%) 7.02 Net Profit 19.98 Following a detailed strategic analysis of the likely future performance of Rapstar after the change of ownership, the following estimates have been made:
-Rapstar would be able to increase the turnover at the rate of 4% per year in real terms for the next three years, after which the turnover is expected to remain stable in real terms.
-Inflation is currently 2½% per annum, and the average inflation rate is expected to continue at this level for the foreseeable future.
-A programme of modernisation and replacement of equipment would generate cost savings that would improve the ratio of operating cost to sales by one percentage point from the previous year's level. This improvement would be achieved in the first year (i.e. 2015-16), and the operating cost ratio would remain at that level thereafter.
-The capital expenditure required to complete the modernisation and replacement programme would be spread over the first three years, and would amount to 25% of the incremental sales in each of those years.
-Other routine capital expenditure would be roughly equal to the annual depreciation charge.
-The average level of working capital maintained by Rapstar plc during any one year is equal to approximately 15% of the sales for that year; working capital would need to be maintained at the level required to sustain the anticipated increase in turnover.
-The rate of corporate taxation would remain at 20%.
-Rapstar plc has no debt.
-Rapstar plc's beta is 1.6, the rate of return on Treasury Bills is 4% and the expected rate of return on the market portfolio is approximately 9%.
Required -
(a) Perform a DCF valuation of Rapstar plc, using Rappaport's shareholder value analysis and the information provided above.
(b) Distinguish between entity valuation and equity valuation, and comment upon the relevance of the distinction in the case of Rapstar plc.
(c) One of Rapstar plc's directors wishes to use a similar DCF method to estimate the value of her small business enterprise (unrelated to Rapstar) which she has been running as a private company for some years. Describe some of the particular problems in using such a technique for a small enterprise.