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
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.
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?