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.
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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