UCD 2019/2020 Page 1 of 7 ___________________________________ AUTUMN TRIMESTER EXAMINATIONS ACADEMIC YEAR 2019/2020 ___________________________________ ACC40700 Strategic Corporate Finance Professor Fanis Tsoligkas Professor Anthony Brabazon Dr John McCallig Mr Jack Massey* Time Allowed: 2 Hours Instructions for Candidates Answer QUESTION 1 (compulsory) AND two of the remaining three questions (2, 3 AND 4). Student Number Seat Number Instructions for Invigilators Closed book examination Use of non-programmable calculators permitted UCD 2019/2020 Page 2 of 7 Section A – You must answer this question Question 1 Healthy Dog Limited (‘HDL’) is a family owned dog food manufacturing company founded five years ago. The company has developed both a highly regarded range of innovative products and a trusted brand. The vast majority of HDL’s sales are to pet shops, but it also sells directly to consumers online. HDL’s founder and CEO, Cooper Boylan, needs additional finance to grow the business internationally and is considering issuing new shares to a private equity investor. Cooper has historically raised debt to expand the business but the company’s banks are reluctant to extend further credit given its leverage is already well above industry norms. Cooper would like your help valuing his company and has shared the recent summary financial statements below. HDL Summary Profit & Loss Account for year ended 30 November 2019 (€000) Sales 13,450 Depreciation 110 EBIT 1,140 Profit after tax (corporation tax rate is 10%) 788 HDL Summary Statement of Financial Position as at 30 November 2019 (€000) Premises, depreciated historic cost 8,200 Stocks and prepayments 450 Trade creditors (295) Bank overdraft (70) Net current assets 85 Bank loans due in greater than one year (4,300) Total net assets 3,985 Ordinary share capital (shares of €1 each) 1,000 Profit and loss reserves 2,985 Shareholders’ equity 3,985 The premises were bought for €9 million but could now be sold for €11.2 million. Cont…./ UCD 2019/2020 Page 3 of 7 Question 1 Continued…/ There are some listed dog food companies comparable to HDL, albeit with lower levels of debt. You have extracted the following average valuation multiples for those companies: Cooper has seen recent generous valuations of ‘infant’ online companies based on applying a multiple to sales. He is keen to apply that valuation basis to HDL. Required: (a) Calculate a per share valuation of HDL based on book values. Provide reasons why this valuation is of limited relevance. (6 marks) (b) Calculate a per share valuation of HDL based on liquidation values. Explain the potential relevance of this valuation in the current scenario. (5 marks) (c) Prepare two different earnings-based multiple valuations of HDL’s equity shares. Explain which one of the two valuations is likely to be the most appropriate. Give reasons why the use of comparable listed company multiples might still not appropriately value HDL. (17 marks) (d) Comment on the likelihood of a sales multiple based valuation being accepted by an equity investor in HDL. Describe the risks of such valuations for an equity investor. (5 marks) (e) Explain which risks equity investors are rewarded for, and not rewarded for, according to the Capital Asset Pricing Model (‘CAPM’). (7 marks) (TOTAL: 40 MARKS) Price / Earnings Ratio 12.0x Enterprise Value / NOPAT Ratio 11.5x UCD 2019/2020 Page 4 of 7 Section B – Answer TWO of the three questions in Section B Question 2 Griffin Hospitality plc (‘GH’) operates 25 four-star hotels across the UK and Ireland. Part of the CEO’s strategy is to exploit the Group’s scale and operational expertise by acquiring poorly managed independent hotels. GH’s chairman is supportive of any acquisitions that are accretive to earnings per share (i.e. increase earnings per share). GH has a Weighted Average Cost of Capital (‘WACC’) of 9.0%. The Northbrook Hotel Limited (‘NHL’) may be a suitable target and GH’s projections for its performance over the next three years are included below. These projections include the benefit of annual synergies of €0.3m after-tax that GH believes it could achieve on acquisition, after incurring once-off implementation costs of €0.5m. Cashflows are forecast to continue to grow at 1.5% per annum post 2022 as a result of inflation. NHL currently has net debt of €4.5m and pays corporation tax at 12.5%. €000 2020 Forecast 2021 Forecast 2022 Forecast Depreciation 75 80 83 Operating profit (EBIT) 1,395 1,515 1,608 Capex 112 98 85 (2020 cashflows are assumed to arise in
exactly one year’s time and so on for 2021 and 2022) Required: (a) Calculate a maximum possible bid by GH for the equity of NHL. Comment briefly on the key risk in your valuation calculation even if the 2020-2022 forecast and WACC are accurate. (17 marks) (b) Given its projections, what should GH bid for the equity of NHL if it wishes to retain half the value created by the acquisition for its own shareholders. (5 marks) (c) Explain in detail why ‘earnings per share accretion’ is not a suitable financial threshold for approving acquisitions. (8 marks) (TOTAL: 30 MARKS) UCD 2019/2020 Page 5 of 7 Question 3 Lean Manufacturing plc’s (‘LM’s’) CFO, Sean Kelly, was reflecting with satisfaction on improved working capital and capex management at the company. LM now had the highest Return on Capital in its sector (11.2% in the last fiscal year based on NOPAT of €22.5m and Long Term Debt plus Equity Capital of €200.6m). Nonetheless Sean was concerned by the recent appearance of an activist investor on the company’s share register. The shareholder had not raised any issues to date but had asked several questions about the absence of debt in LM’s capital structure at their initial meeting. A prominent investment bank had recently pitched the idea of an LM bond issue to Sean, with the proceeds being used to return capital to shareholders. They believed LM could issue €50m face-value, 5 year, 5.5% coupon debt at 105% of nominal value, without any material adverse impact on LM’s equity risk profile. LM pays corporation tax at 12.5%. Sean was considering the options for distributing the bond proceeds to shareholders. Low interest rates are currently giving LM a cost of equity of 8.6%. Sean, however, is concerned that when interest rates eventually start to rise, LM’s cost of equity will increase and its share price will fall. LM has now matured to have relatively stable surplus annual cashflows and Sean believes LM could sustain a regular dividend pay-out ratio of approximately 33%. Required: (a) Explain why the activist investor may be dissatisfied with LM’s returns to shareholders despite its sector-leading Return on Capital. (6 marks) (b) Calculate the impact on LM’s WACC of the possible bond issue. (14 marks) (c) Provide recommendation(s) to Sean for distributing ongoing surplus cashflows and the bond proceeds to shareholders. (10 marks) (TOTAL: 30 MARKS) UCD 2019/2020 Page 6 of 7 Question 4 Answer both parts of this question. Part (a) A friend is excited about the potential returns from investing in shares listed in Imaginland, a liberalising former communist country. Her stockbroker, however, has cautioned her about potential ‘agency problems’ investing in a country and in listed companies where there might not be a well-developed corporate governance regime. Explain the issue being raised by the stockbroker and the features your friend might look for in the Imaginland regime to satisfy herself that she will be adequately protected as a shareholder. (15 marks) Part (b) Theoretical models exist that suggest both a company’s choice of capital structure and its dividend policy are irrelevant to the value of the firm. Briefly explain the core rationale for each of these theories and the assumptions they depend upon which are very unlikely to apply in reality. (15 marks) (TOTAL: 30 MARKS) – oOo – GENERAL FINANCE FORMULAE Present value of a perpetuity PV0 = CF1 / r Terminal Value TV0 = CF1 / (r – g) Ke = rf + β(rm – rf) WACC = Ke x (E / D+E) + [Kd * (1-t)] x (D/ D+E) PRESENT VALUE DISCOUNT FACTORS Discount Rate Time 4% 4.5% 5% 6% 7% 8% 9% 10% 11% 12% 13% 0 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1 0.9615 0.9569 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 2 0.9246 0.9157 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.8116 0.7972 0.7831 3 0.8890 0.8763 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7312 0.7118 0.6931 4 0.8548 0.8386 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6587 0.6355 0.6133 5 0.8219 0.8025 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5935 0.5674 0.5428 6 0.7903 0.7679 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5346 0.5066 0.4803 7 0.7599 0.7348 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4817 0.4523 0.4251 8 0.7307 0.7032 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4339 0.4039 0.3762 9 0.7026 0.6729 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3909 0.3606 0.3329 10 0.6756 0.6439 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3522 0.3220 0.2946 Page 7 of 7