7 As a defence against a possible takeover bid the managing director proposes that Woppit make a bid for Grapper plc, in order to increase Woppit’s size and, hence, make a bid for Woppit more difficult. The companies are in the same industry.

Woppit’s equity Beta is 1.2 and Grapper’s is 1.05. The risk-free rate and market return are estimated to be 10 and 16 per cent p.a. respectively. The growth rate of after-tax earnings of Woppit in recent years has been 15 per cent p.a. and of Grapper 12 per cent p.a. Both companies maintain an approximately constant dividend payout ratio.

Woppit’s directors require information about how much premium above the current market price to offer for Grapper’s shares. Two suggestions are:

(i) The price should be based upon the Balance Sheet net worth of the company, adjusted for the current value of land and buildings, plus estimated after tax profits for the next five years.

(ii) The price should be based upon a valuation using the Dividend Valuation Model, using existing growth rate estimates Summarised financial data for the two companies are shown below:

The current share price of Woppit is 310 pence and of Grapper 470 pence.
Required

(a) Calculate the premium per share above Grapper’s current share price that would result from the two suggested valuation methods. Discuss which, if either, of these values should be the bid price. State clearly any assumptions that you make.

(b) Assess the managing director’s strategy of seeking growth by acquisition in order to make a bid for Woppit more difficult.

(c) Illustrate how Woppit might achieve benefits through improvements in operational efficiency if it acquires Grapper.

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Most recent Balance Sheets (Em) Woppit Grapper Land and buildings (net)" 560 150 Plant and machinery (net) Stock Debtors 720 280 Bank Less: Trade creditors Overdraft Tax payable Dividends payable Total assets less current liabilities Financed by: Ordinary shares (200) 240 210 660 40 490 (110) (30) (120) (10) (40) (50) (400) (200) 1,540 720 200 100 Share premium 420 220 Other reserves 400 300 1,020 620 Loans due after one year 520 100 1,540 720