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Phobis Co. (Dec 07 – Amended)

Phobis Co is considering a bid for Danoca Co. Both companies are stock-market listed and are in the same business sector. Financial information on Danoca Co, which is shortly to pay its annual dividend, is as follows:

Number of ordinary shares

5 million

 Ordinary share price (ex div basis)

$3.30

Earnings per share

40.0c

Proposed payout ratio

60%

Dividend per share one year ago

23.3c

Dividend per share two years ago

22.0c

Equity beta

1.4

Other relevant financial information

Average sector price/earnings ratio

10

Risk-free rate of return

4.6%

Return on the market

10.6%

Required:

Calculate the value of Danoca Co using the following methods:

(i) price/earnings ratio method
(ii) dividend growth model

and discuss the significance, to Phobis Co, of the values you have calculated, in comparison to the current market value of Danoca Co.

B. Phobis Co has in issue 9% bonds which are redeemable at their par value of $100 in five years’ time. Alternatively, each bond may be converted on that date into 20 ordinary shares of the company. The current ordinary share price of Phobis Co is $4.45 and this is expected to grow at a rate of 6.5% per year for the foreseeable future. Phobis Co has a cost of debt of 7% per year.

Required:

Calculate the following current values for each $100 convertible bond:

(i) market value
(ii) floor value
(iii) conversion premium

C. Discuss the significance to a listed company if the stock market on which its shares are traded is shown to be semi-strong form efficient.

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