The managing directors of Wrack plc are considering what value to place on Trollope plc, a company which they are planning to take over in the near future. Wrack plc’s share price is currently £4.21 and the company’s earnings per share stand at 29p.

Wrack’s weighted average cost of capital is 12 per cent.

The board estimates that annual after-tax synergy benefits resulting from the takeover will be £5m, that Trollope’s distributable earnings will grow at an annual rate of 2 per cent and that duplication will allow the sale of £25m of assets, net of corporate tax (currently standing at 30 per cent), in a year’s time. Information referring to Trollope plc:

(a) Given the above information, calculate the value of Trollope plc using the following valuation methods:
(i) price/earnings ratio;
(ii) dividend valuation method;
(iii) discounted cash flow method.

(b) Discuss the problems associated with using the above valuation techniques.
Which of the values would you recommend the board of Wrack to use?

(c) Critically discuss which factors will influence a company to finance a takeover by either a share-for-share offer or a cash offer financed by an issue of bonds.

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Financial position statement of Trollope ple m m Non-current assets 296 Current assets 70 Current liabilities 52 18 314 Financed by: Ordinary shares, 1 Reserves Net equity interest 7 per cent bonds Income statement extracts 156 75 231 83 314 m Profit before interest and tax 76.0 Interest payments 8.3 67.7 Corporate tax payments 20.3 Distributable earnings 47.4 Other information: Current ex-div share price Latest dividend payment 2.25 16p