Yellow plc
The following scenario relates to questions 297–301
Yellow plc is a growing company specialising in making accessories for mobile phones and tablets. The company is currently all-equity financed with 2 million ordinary shares in issue. The existing shareholders are mainly family members and friends. The directors of Yellow need to raise finance to fund a new factory and are considering a range of options including flotation and venture capital. Future growth is anticipated to be the following:
Earnings next year = $0.25m, expected to grow at 7% pa
Dividend next year = $0.14m, expected to grow at 4% pa
Flotation
Tulip plc, a listed company with similar business activities to Yellow has a P/E ratio of 9, an equity beta of 1.2 and gearing, measured as Debt: Equity of 1:2. Yellow is expected to grow faster than Tulip plc, at least in the short term.
If flotation is approved, then the issue share price would be set at a 15% discount to fair value. The directors of Yellow do not believe that an asset valuation is of much use here.
Venture capital
The directors of Yellow have been in discussion with 4Ts, a listed venture capital company. As well as contributing equity, 4Ts would seek to spread the risk of their investment by also investing in the form of 4–year 5% secured redeemable bonds and also convertible preference shares. The risk adjusted return on similar bonds has been estimated at 6%.
Corporation tax is currently 30%.
297. Which of the following statements, concerning the usefulness of asset based methods of business valuation, is correct?