Macaroon Holdings Limited is a South African consumer goods company that is listed on the JSE. Macaroon also operates in the rest of Africa where it is determined to open another twenty retail stores over the next five years.

An overseas retail company has offered to purchase 55% of Macaroon. Management has asked you to assist with the valuation of Macaroon for the purpose of this takeover offer. They provided you with the necessary financial information.

The share price of Macaroon on various dates are as follows:

30 June 202212 400 cents

30 June 202111 800 cents

30 June 20208 800 cents

30 June 20196 170 cents

The financial results of Macaroon for the year ending 30 June 2022 are provided below:

Statement of comprehensive income for the year ending 30 June 2022

Notes20222021

R millionR million

Turnover147 45143 129

Cost of sales38 879 35 351

Gross profit2 8 572 7 778

Other operating expenses 3 7 000 5 000

Depreciation4 176 160

Dividends received5 110 100

Rental income received6 159 147

Profit before interest and tax 1 665 2 865

Interest paid7 93 113

Profit before tax 1 572 2 752

Tax 605 630

Profit after tax 967 2 122

Outside shareholders interest 82 71

Profit for the year 885 2 051

Notes:

1. Growth in turnover is expected to be 15% for the next two years. Growth in perpetuity is expected to be in line with CPI inflation of 5%

2. The gross profit margin is expected to be 20% for the foreseeable future.

3. Other operating expenses is expected to be 10% of turnover for the foreseeable future. Included in operating expenses is the municipal rates incurred on the investment property and is R10 million for 2021 and R11 million for 2022. This is expected to grow at 6% in the foreseeable future. (refer note 6). Also included in the other operating expenses for 2022 is an amount of R20 million which was due to a once-off fine being paid to the Competition Commission.

Statement of financial position at 30 June 2022

Notes20222021

R millionR million

Non-current assets

Property, plant and equipment (PPE)4 4 600 4 200

Investment property6 3 055 2 697

Investment in Manchester United5 686 634

Current Assets

Inventory8 5 602 4 893

Accounts receivable8 2 323 1 851

Cash and cash equivalents8 1 390 1 385

Total assets17 65615 660

Equity

Share capital 400 400

Retained earnings 3435 2 787

Outside shareholders interest 124 42

Non-current liabilities

Interest bearing long-term loans7 2 895 2 859

Current liabilities

Accounts payable8 9 220 7 693

SARS81202 1 490

Short term portion of long-term loans7 380 389

Total equity and liabilities17 656 15 660

Notes continue:

4. The growth in the closing PPE balance is expected to be 5% for the next 2 years and thereafter expected to be in line with CPI inflation of 5%. Depreciation is forecasted to be 8% of the opening balance of PPE. Wear and Tear is expected to approximate depreciation.

5. Dividends received relates to Macaroons investment in Manchester United Football Club. Manchester United expects to achieve a dividend of R120 million in 2023 and thereafter the growth can be assumed to be 5%. Expected returns on similar investments in European Football Clubs are 19%, but you can assume that the investment in Manchester United is a bit more risky than the other clubs because of the poor performance over the last few years.

6. Rental income relates to Macaroons investment property. Rental escalations signed by tenants amounts to 6% for the foreseeable future and the directors are of the opinion that the risk appropriate rate for their investment property should be 10% before tax.

7. The interest paid relates to Macaroons interest-bearing loans. The loan will be paid back over four years and then Macaroon plans to replace the loan with new debentures. The market rate on similar loans is 10%.

8. The current assets (including cash which is regarded as 50% operating) will increase annually by only 4% for the next two years as the company moves towards a leaner working capital investment, while current liabilities (excluding the short-term portion of interest-bearing loans) will increase by 3% per annum for the next two years. Thereafter the increases will be in line with the CPI index of 5%.

Other relevant information relating to Macaroon Holdings Limited:

Growth in company cash flows after 20245%

Number of shares issued250 million

Earnings per share at 30 June 2022R8

Dividend pay-out ratio at 30 June 202250%

Dividend growth for the foreseeable future8%

Cost of debt before tax10%

Corporate tax rate30%

Target debt ratio30%

Required:

As an overseas company is interested in buying 55% of the shareholding of Macaroon, the management team discussed a few issues in a recent board meeting and you have to give feed back to them as soon as possible. Please state your feedback with reasons and/or assumptions as valuations are very subjective and your answers should be clear and understandable for the whole management team.

(a) Should they use the Dividend Growth model or the Free Cash Flow model to value the 55% shareholding?(4 marks)

(b) Management wants to use the FCF model and decides that the cost of equity should be used to discount the operating cash flows as the target debt ratio is 30%. Your opinion on this statement?(2 marks)

(c) Management wants to use the historical and the liquidation value of the assets to check the Free Cash Flow value of the 55% shareholding in Macaroon. Your opinion on this statement?(2 marks)

(d) Assume Weighted Average Cost of Capital is 10%, calculate the value of one share in Macaroon (tip: remember to do t accounts to check the in-and outflow of working capital, capex and tax).(35marks)

(e) Do you think, given the price calculated in (d), that it would be a worthwhile investment for the overseas investor?(2