(b)Oakton Ltd, a company quoted on the ASX, has cash balances of $23 million which are currently invested in short-term money market deposits. The cash is intended to be used primarily for strategic acquisitions, and the company has formed an acquisition committee with a role to identify possible acquisition targets. The committee has suggested the purchase of a smaller company, Mallard Pty Ltd, an unquoted company in a different industry. The directors of Mallard have indicated they might be prepared to sell for $22 million.

Oakton Mallard

$000 $000

Turnover 480,000 38,000

Pretax operating cash flow 51,000 5,300

Taxation (33%) 16,830 1,749

Post tax operating cash flow 34,170 3,551

Dividend 11,000 842

Fixed assets (net) 168,000 8,400

Current assets 135,000 4,700

Current liabilities 99,680 3,900

203,320 9,200

Financed by

Ordinary shares (25c par) 10,000 (10c par) 500

Reserves 158,320 5,200

12% debentures 20,000

10% bank loan 15,000

11% bank loan 3,500

203,320 9,200

Current share price 785 cents 370 cents

Earnings yield 10.9% 19.2%

Av. Dividend growth over past 5 years 7% pa 8% pa

Equity beta 0.95 0.8

Industry data:

Average P/E ratio 10:1 7:1

Average P/E of companies recently

Taken over, based on the offer price 12:1

The risk-free rate of return is 6% per annum and the market return 14% per annum. Land and Buildings is shown at a book value of $5 million but has never been revalued to current market value. The current replacement cost for these land and buildings is estimated at $12 million. If Oakton acquires Mallard it expects to restructure and save $750,000 in salaries, reduce advertising by $150,000, but incur an additional $300,000 in consultancy costs.

Required:

A) Estimate the value of Mallard based upon:

(i) the use of comparative P/E ratios

(ii) the dividend valuation model

(iii) asset valuation method

and critically discuss the advantages and disadvantages of each of the three valuation methods.

iv) Recommend whether or not Oakton should offer $22 million for Mallard and state the value of Goodwill that would be established if the sale proceeds.

B) Briefly discuss the factors that might influence whether Oakton uses its cash balances rather than shares or bonds, to make payment for Mallard.

C) Discuss the importance of financial post-audits following a merger or takeover.