The most recent statement of financial position for Vadeema plc is given in the following table. Vadeema is a stock market-quoted company that specialises in researching and developing new pharmaceutical compound. It either sells or licenses its discoveries to larger companies, although it operates a small manufacturing capability of its own, accounting for about half of its turnover:

Statement of financial position as at 30 June 2014 Assets employed Fixed (non-current) assets Tangible Intangible Current assets Stock and work-in-progress Debtors Bank Current liabilities Trade creditors Bank overdraft Net current assets 10% loan stock Net assets Financed by Ordinary shares capital (25p par value)

Share premium account Revenue reserves Shareholders’ funds

£m 50 120 80 20 5

(10)

(20)

£m 105

(30)

£m 170 75

(40)

205 100 50 55 205 Further information:

1 In 2017–18, Vadeema made sales of £300 million, with a 25 per cent net operating margin (i.e. after depreciation but before tax and interest).

2 The rate of corporate tax is 33 per cent.

3 Vadeema’s sales are quite volatile, having ranged between £150 million and £350 million over the previous five years.

4 The tangible fixed assets have recently been revalued (by the directors) at £65 million.

5 The intangible assets include a major patent (responsible for 20 per cent of its sales) which is due to expire in April 2015. Its book value is £20 million.

6 50 per cent of stocks and work-in-progress represents development work for which no firm contract has been signed (potential customers have paid for options to purchase the technology developed).

7 The average P:E ratio for quoted drug research companies at present is 22:1 and for pharmaceutical manufacturers is 14:1. However, Vadeema’s own P:E ratio is 20:1.

8 Vadeema depreciates tangible fixed assets at the rate of £5 million p.a. and intangibles at the rate of £25 million p.a.

9 The interest charge on the overdraft was 12 per cent.

10 Annual fixed investment is £5 million, none of which qualifies for capital allowances.

Required

(a) Determine the value of Vadeema using each of the following methods:

(i) net asset value;

(ii) price:earnings ratio;

(iii) discounted cash flow (using a discount rate of 20 per cent).

(b) How can you reconcile any discrepancies in your valuations?

(c) To what extent is it possible for the stock market to arrive at a ‘correct’ valuation of a company like Vadeema?