Case Study: Valuation of Grimgotts Bank by Gekko Holdings plc Gekko Holdings plc, a multi-division conglomerate, has taken a strategic decision to acquire Grimgotts Bank Limited, a retail bank operating in the United Kingdom. For this purpose the treasury team of Gekko Holdings plc has been asked to estimate the equity value of Grimgotts Bank Limited. The treasury team intend to use the dividend discount valuation model but the company's Chairman has asked that they also estimate the equity value using the earnings valuation technique, and compare the two results. For valuing Grimgotts Bank, the treasury team has been asked to use relevant data relating to three companies quoted on the London Stock Exchange that are engaged in the same line of activity and have broadly similar levels of gearing. The three companies that have been identified for this purpose, with their London Stock Exchange symbols, are NatWest Group plc (NWG.L), Standard Chartered plc (STAN.L) and Virgin Money UK plc (VMUK.L). Grimgotts Bank earned a net profit of 174 million in the year just ended (namely its financial year ended 31st December 2021), and the dividend payout ratio was 20 percent. The profits and dividends have recently been growing at a rate of 15 percent per year. It is expected that this high rate of growth will continue for the next five years, after which it is expected to stabilise at a lower average rate of growth which would remain steady for the foreseeable future thereafter. Grimgotts Bank's healthy rate of profit retention is expected to result in the book value of its equity reaching a level of 3.5 billion by 31st December 2025 . The rate of return on equity achieved in the following year (2026) is expected to continue unchanged for the foreseeable future, but the dividend payout ratio is expected to be doubled to 40 percent from the year 2027 onwards. This will result in a spurt in the dividend paid in the year 2027 , but thereafter the dividend is expected to grow steadily at a rate determined by the rate of return on equity and the new dividend payout ratio of 40%. The above information has been obtained in the course of discussions with the management of Grimgotts Bank, which is not averse to the proposed takeover. The discount rate for performing this evaluation is to be arrived at by adding an appropriate risk premium to the annual effective yield on 91-day Treasury Bills. Such bills are currently trading at a market price of 99.05 per 100 nominal, and the simple yield is generally calculated on ACT/365 basis. The risk premium on the FTSE All Share Index is currently estimated at 6.4 percent. To simplify your calculations assume that today's date is 1st January 2022 and that Grimgotts Bank's annual dividends are paid on 31st December in the same year in which the related profits are earned. Required: A Perform an equity valuation of Grimgotts Bank using the suggested techniques, compare the results obtained, and discuss the reasons why it would be unusual for these different techniques to yield closely similar results. B Cost of capital i) Discuss the practical problems of calculating an appropriate cost of capital using the Capital Asset Pricing Model, and comment on how most stock market quoted firms tend to deal with these problems. ii) Discuss the particular problems of estimating a cost of capital for unquoted companies. (20 marks) C One of the directors has remarked that the value of Grimgotts Bank may be significantly different after control of the firm is achieved by Gekko Holdings. Explain why the value of Grimgotts Bank might change if control of the firm is achieved by Gekko Holdings. How might the acquiring company try to take this into account in valuing the acquisition, and what type of problems may be encountered in doing so? (15 marks) In addition to 65 marks for academic and technical content as indicated above, marks will be also be awarded for professional skills under the following heads: Demonstration of expertise and skills in producing and writing business reports containing financial analysis - essentially the preparation and presentation of a report to the top management of a company, using standard business software. (circa 15 marks) Demonstration of researching, planning and organizational skills - evidence of background reading, teamworking, following of the coursework assignment's requirements (including instructions relating to formation of groups), etc. (circa 5 marks) Demonstration of expertise and skills making oral presentations - quality of the group presentation which each group will be expected to make to the Chairman; individual marks for the presentation will depend not only on the overall quality of the team effort, but also the individual presentation skills demonstrated. (circa 15 marks) Case Study: Valuation of Grimgotts Bank by Gekko Holdings plc Gekko Holdings plc, a multi-division conglomerate, has taken a strategic decision to acquire Grimgotts Bank Limited, a retail bank operating in the United Kingdom. For this purpose the treasury team of Gekko Holdings plc has been asked to estimate the equity value of Grimgotts Bank Limited. The treasury team intend to use the dividend discount valuation model but the company's Chairman has asked that they also estimate the equity value using the earnings valuation technique, and compare the two results. For valuing Grimgotts Bank, the treasury team has been asked to use relevant data relating to three companies quoted on the London Stock Exchange that are engaged in the same line of activity and have broadly similar levels of gearing. The three companies that have been identified for this purpose, with their London Stock Exchange symbols, are NatWest Group plc (NWG.L), Standard Chartered plc (STAN.L) and Virgin Money UK plc (VMUK.L). Grimgotts Bank earned a net profit of 174 million in the year just ended (namely its financial year ended 31st December 2021), and the dividend payout ratio was 20 percent. The profits and dividends have recently been growing at a rate of 15 percent per year. It is expected that this high rate of growth will continue for the next five years, after which it is expected to stabilise at a lower average rate of growth which would remain steady for the foreseeable future thereafter. Grimgotts Bank's healthy rate of profit retention is expected to result in the book value of its equity reaching a level of 3.5 billion by 31st December 2025 . The rate of return on equity achieved in the following year (2026) is expected to continue unchanged for the foreseeable future, but the dividend payout ratio is expected to be doubled to 40 percent from the year 2027 onwards. This will result in a spurt in the dividend paid in the year 2027 , but thereafter the dividend is expected to grow steadily at a rate determined by the rate of return on equity and the new dividend payout ratio of 40%. The above information has been obtained in the course of discussions with the management of Grimgotts Bank, which is not averse to the proposed takeover. The discount rate for performing this evaluation is to be arrived at by adding an appropriate risk premium to the annual effective yield on 91-day Treasury Bills. Such bills are currently trading at a market price of 99.05 per 100 nominal, and the simple yield is generally calculated on ACT/365 basis. The risk premium on the FTSE All Share Index is currently estimated at 6.4 percent. To simplify your calculations assume that today's date is 1st January 2022 and that Grimgotts Bank's annual dividends are paid on 31st December in the same year in which the related profits are earned. Required: A Perform an equity valuation of Grimgotts Bank using the suggested techniques, compare the results obtained, and discuss the reasons why it would be unusual for these different techniques to yield closely similar results. B Cost of capital i) Discuss the practical problems of calculating an appropriate cost of capital using the Capital Asset Pricing Model, and comment on how most stock market quoted firms tend to deal with these problems. ii) Discuss the particular problems of estimating a cost of capital for unquoted companies. (20 marks) C One of the directors has remarked that the value of Grimgotts Bank may be significantly different after control of the firm is achieved by Gekko Holdings. Explain why the value of Grimgotts Bank might change if control of the firm is achieved by Gekko Holdings. How might the acquiring company try to take this into account in valuing the acquisition, and what type of problems may be encountered in doing so? (15 marks) In addition to 65 marks for academic and technical content as indicated above, marks will be also be awarded for professional skills under the following heads: Demonstration of expertise and skills in producing and writing business reports containing financial analysis - essentially the preparation and presentation of a report to the top management of a company, using standard business software. (circa 15 marks) Demonstration of researching, planning and organizational skills - evidence of background reading, teamworking, following of the coursework assignment's requirements (including instructions relating to formation of groups), etc. (circa 5 marks) Demonstration of expertise and skills making oral presentations - quality of the group presentation which each group will be expected to make to the Chairman; individual marks for the presentation will depend not only on the overall quality of the team effort, but also the individual presentation skills demonstrated. (circa 15 marks)