Question 2 Potter plc (Potter) is preparing to make a bid to buy a rival unlisted company, Weasley Ltd (Weasley), which operates in the same business sector. Relevant financial information for both companies is as follows: Potter Weasley PIC m 46 13 Ordinary share capital (nominal value 1) 7% bonds, redeemable at par in four years' time Potter has an equity beta of 1.2. The risk-free rate of return is 2.5% and the average retum on the market is 7.5%. The 7% bonds are trading at 94 per 100 ex-interest. The ex-div share price of Potter is 2.75 per share and its P/E ratio is 7. Potter believes that its P/E ratio will remain unchanged following the acquisition. The current earnings per share of Weasley is 2.30 and the company maintains a dividend pay-out ratio of 30% every year. Its earnings and hence dividends have grown at an average rate of 3.5% per annum in recent years. Weasley has a cost of equity of 9%. Corporation tax is payable at a rate of 20%. Required (a) Calculate the weighted average cost of capital of Potter Plc. (13 marks) (b) Calculate the value of Weasley Ltd using the following valuation methods: (1) P/E ratio method (ii) Dividend growth model. (6 marks) (c) Discuss the validity of the assumptions that underlie the valuation methods used in part (b), and the suitability of using each method to value the company's shares. (6 marks) (Total 25 marks) TURN OVER