Question

3. John Jones is head of the research department of Peninsular Research. Once of the companies...

3. John Jones is head of the research department of Peninsular Research. Once of the companies he is researching, MacKinac Plc., is a UK-based manufacturing company. Mackinac has released the June 2007 financial statements shown in Exhibits 1, 2, and 3.

Exhibit 1: Mackinac Plc. Annual Income Statement 30 June 2019 (in thousands, except per-share data)

Sales £250,000

Cost of goods sold 125,000

Gross operating profit 125,000

Selling, general, and administrative expenses 50,000

EBITDA 75,000

Depreciation and amortization 10,500

EBIT 64,500

Interest expense 11,000

Pretax income 53,500

Income taxes 16,050

Net income £37,450

Shares outstanding 13,000

EPS £2.88

Exhibit 2: MacKinac Plc

. Balance Sheet 30 June 2019 (in thousands)

Current Assets Cash and equivalents £20,000

Receivables 40,000

Inventories 29,000

Other current assets 23,000

Total current assets £112,000

Non-current Assets Property, plant, and equipment £145,000

Less: Accumulated depreciation 43,000

Net property, plant, and equipment 102,000

Investments 70,000 Other noncurrent assets 36,000

Total non current assets 208,000

Total Assets £320,000

Current Liabilities Accounts payable £41,000

Short-term debt 12,000

Other current liabilities 17,000

Total current liabilities £70,000

Non-Current Liabilities Long-term debt 100,000

Total non-current liabilities 100,000

Total liabilities 170,000

Shareholders’ Equity Common equity 40,000

Retained earnings 110,000

Total equity 150,000

Total liabilities and equity £320,000

Exhibit 3:

MacKinac Plc. Statement of Cash Flows 30 June 2019 (in thousands) Cash Flow from Operating Activities Net income £37,450

Depreciation and amortization 10,500

Change in Working Capital (Increase) decrease in receivables (£5,000)

(Increase) decrease in inventories (8,000) Increase (decrease) in payables 6,000 Increase (decrease) in other current liabilities 1,500

Net change in working capital (5,500)

Net cash from operating activities £42,450

Cash Flow from Investing Activities Purchase of property, plant, and equipment (£15,000)

Net cash from investing activities (£15,000) Cash Flow from Financing Activities Change in debt outstanding £4,000

Payment of cash dividends (22,470) Net cash from financing activities (18,470)

Net change in cash and cash equivalents £8,980

Cash at beginning of period 11,020

Cash at end of period £20,000

MacKinac has announced that it has finalised an agreement to handle

European production of a successful product currently marketed by a company headquartered outside Europe. Jones decides to value MacKinac by using the dividend discount (DDM) model and the Free Cash Flow to Equity (FCFE) model. After reviewing MacKinac’s financial statements and forecasts related to the new production agreement, Jones concludes the following: • MacKinac’s earnings and FCFE are expected to grow 17 percent a year over the next three years before stabilizing at an annual growth rate of 9 percent.

• MacKinac will maintain the current payout ratio

. • MacKinac’s beta is 1.25. The government bond yield is 6 percent and the market equity risk premium is 5 percent. Required:

Q)Jones is discussing with a corporate client the possibility that the client will acquire a 70 percent interest in Mackinac. Discuss whether the DDM or FCFE model is more appropriate for this client’s valuation purposes.

Homework Answers

Answer #1

Q)Jones is discussing with a corporate client the possibility that the client will acquire a 70 percent interest in Mackinac. Discuss whether the DDM or FCFE model is more appropriate for this client’s valuation purposes.

Both the model is suitable for this company since the company is predicted to create stable and positive cashflow as well as it has a constant payout ratio. However from the perspective of acquisition, the acquirer will be more interested in future cashflows rather than the payment done to shareholders. Hence if the future cashflows are relatively accurate it will provide a real picture about the companys performance to the corporate client rather than the obligation of paying dividend to the shareholders.

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