Question 3

BF109 Ltd and ME262 Ltd operate in the same industry. BF109 is contemplating to launch a takeover of ME262. BF109s earnings multiple is 15 times.

ME262 Ltd is expected to pay its annual dividend soon, based on the proposed retention ratio of 27 percent. Recently, the announced earnings were $0.50 per share. ME262s management maintains a policy of steadily increasing dividends where dividend per share were $0.30, $0.32, $0.34, $0.35 and $0.365 for the last five years.

ME262 Ltd has 8 million shares outstanding where each share is priced at $4.00 on an ex-dividend basis. The beta of ME262's stock is 1.8. The market risk premium on the countrys stock index was 7 percent the last 10 years. The T-bill rate is 2 percent.

Required:

a) Compute the total share value of ME262 as a takeover target using the Price/earnings ratio method. Discuss the significance of the difference between the PERs of the two companies. (20 marks)

b) Compute the value of ME262's shares using the Dividend Discount Model. (20 marks)

c) For the takeover, what would be the range of share values for negotiation? (10 marks)