Q. Illustrate dividend valuation model?
The business is being acquired as a going concern and earnings valuations rather than asset valuations are recommended. Even these are bear on to a large margin of error. Two probable methods are
(1) The P/E ratio
(2) The dividend valuation model other alternatives may be acceptable.
The P/E ratio method principles a company by multiplying earnings available to ordinary shareholders by the P/E ratio itself. Post-acquisition earnings relatively than historic earnings should be used if possible. The corporate tax rate seems to be approximately 30% per year. If pre-tax earnings are expected to rise by 10% then post-tax earnings should increase by a similar amount. The problem once more exists of how many years' earnings to take. The simplest process is just to use current post-tax earnings but some analysts use the average of five years expected earnings.
If five years expected post-tax profits are utilize the average is
(237 + 260 + 286 + 315 + 346)/2= $288,800
P/E ratios of AIM listed companies in the similar industry are
1/0.12= 8.333
If this is utilized to value Endess the valuation is 8.333 × $288800 = $2406570. Unlisted companies are frequently valued at a lower P/E than a comparable listed company. This may be for the reason that of the lack of marketability of the company's shares less prestige less flexibility and often greater cost in fund raising.
If a P/E of 6 is used the valuation becomes: $1732800.
If only current earnings are utilized with a P/E of 8.333 the value is $1791595 (8.333 * $215000) or with a P/E of 6 $1290000. These values tender broad guidelines only. The dividend valuation replica values the company's stream of expected future dividends. It is approximate using
P =D1/Ke- g
Where D1 is the next dividend Ke is the company's cost of equity as well as g is the expected growth rate in dividends.
P =115 (1. 10))/ 0.18- 0.10= $1581250
Weaknesses of the model comprise the assumption that growth will be at a constant rate and the fact that dividend levels may be determined by directors for other than market reasons especially in an unlisted company. The level of dividends will depend upon how lot the directors wish to withdraw from the company especially for their own requires as owners of 95% of the shares. If this method is utilized it would be better to base it upon the expected dividend level post-acquisition not the current dividends. Additionally the share price is likely to be influenced by other factors besides dividend growth.