Question 12.SE.6: Larkin Conglomerates plc owns a subsidiary, Hughes Ltd, whic...
Larkin Conglomerates plc owns a subsidiary, Hughes Ltd, which sells office equipment. Recently, Larkin Conglomerates plc has been reconsidering its future strategy and has decided that Hughes Ltd should be sold off. The proposed divestment of Hughes Ltd has attracted considerable interest from other businesses wishing to acquire this type of business. The most recent financial statements of Hughes Ltd are as follows:
| Statement of financial position as at 31 May Year 5 | |
| £000 | |
| ASSETS | |
| Non-current assets(cost less depreciation) | |
| Property | 200 |
| Motor vans | 11 |
| Fixtures and fittings | \underline{8} |
| \underline{219} | |
| Current assets | |
| Inventories | 34 |
| Trade receivables | 22 |
| Cash at bank | \underline{20} |
| \underline{76} | |
| Total assets | \underline{259} |
| £000 | |
| EQUITY AND LIABILITIES | |
| Equity | |
| £1 ordinary shares | 60 |
| General reserve | 14 |
| Retained earnings | \underline{55} |
| \underline{129} | |
| Non-current liabilities | |
| 12% loan: Cirencester bank | \underline{100} |
| Current liabilities | |
| Trade payables | 52 |
| Tax and accruals | \underline{14} |
| \underline{66} | |
| Total equity and liabilities | \underline{295} |
| Income statement for the year ended 31 May Year 5 | |
| £000 | |
| Sales revenue | \underline{352.0} |
| Profit before interest and taxation | 34.8 |
| Interest charges | \underline{(12.0)} |
| Profit before taxation | 22.8 |
| Tax | \underline{(6.4)} |
| Profit for the year | \underline{16.4} |
A dividend of £4,000 was proposed and paid during the year.
The subsidiary has shown a stable level of sales and profits over the past three years. An independent valuer has estimated the current realisable values of the assets of the business as follows:
| £000 | |
| Property | 235 |
| Motor vans | 8 |
| Fixtures and fittings | 5 |
| Inventories | 36 |
For the remaining assets, the statement of financial position values are considered to reflect their current realisable values.
Another business in the same industry, which is listed on the Stock Exchange, has a gross dividend yield of 5 per cent and a price/earnings ratio of 12. Assume a tax rate of 25 per cent.
Required:
(a) Calculate the value of an ordinary share in Hughes Ltd using the following methods:
(i) Net assets (liquidation) basis
(ii) Dividend yield
(iii) Price/earnings ratio.
(b) Briefly state what other information, besides the information provided above, would be useful to prospective buyers in deciding on a suitable value to place on the shares of Hughes Ltd.
Larkin Conglomerates plc
(a) The value of an ordinary share in Hughes Ltd according to the three methods is calculated as follows:
(i) Net assets (liquidation) basis:
P_{0} =\frac{ Total assets at realisable values − Total liabilities}{No. of ordinary shares}
= \frac{£(326 − 166)}{60}
= \frac{£160}{60}
= £2.67
(ii) Dividend yield method:
P_{0} =\frac{(Net dividend per share × 100/75)}{Gross dividend yield}× 100
= \frac{(4.0/60.0) × 100/75}{5}× 100
= £1.78
(iii) Price/earnings ratio method:
P_{0} = P/E ratio × earnings per share
= 12 × (£16.4/60)
= £3.28
(b) Other information might include:
● Details of relations with suppliers, employees, the community and other stakeholders should be ascertained.
● The nature and condition of the assets owned by the target business should be examined. The suitability of the assets and their ability to perform the tasks required will be vitally important.
● Key personnel will need to be identified and their intentions with regard to the businessfollowing the takeover must be ascertained.
● Onerous commitments entered into by the business (for example, capital expenditure decisions, contracts with suppliers) must be identified and evaluated.
● Details of the state of the order book, the market share of the products or services provided by the business and the loyalty of its customers should be established.
● Examination of the budgets which set out expected performance levels, output levels and future financing needs would be useful.
● Information concerning the cost structure of the business would be useful.