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Question

The managing directors of revolution bikes are considering what value to place on the Racer Bicycle Company, a

company which they are considering to acquire in the near future. Revolution Bikes' share price is currently £4.21, and the company's earnings per share stand at 29p. Racer Bicycle Co. Weighted average cost of capital is 12%.

The board estimates that annual after-tax synergy benefits resulting from the takeover will be £5m, that Racer Bicycle's distributable earnings will grow at an annual rate of 2%, and the duplication will allow the sale of £25m of assets, net of corporate tax (currently standing at 30%), in a year's time, information referring to Racer Bicycle Co. Is as follows.

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Additional information:

Revolution Bikers has grown steadily for several years, but increasingly competitive market conditions are forecast for 2019. The directors of Revolution Bikes believe it would be preferable to acquire Racer Bicycle Company in order to achieve greater efficiencies and to speed the development of new income streams.

Sonic Cycles, Lightning, Woodlands Bicycles, and Trail Tracker, four companies listed on the London Stock Exchange are in the same industry as Racer Bicycle Co., and their latest key investor ratios are shown below:

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Large companies in the same industry typically apply a risk-adjusted, after-tax cost of capital of about 12% to acquisition proposals.

 

Requirements:

1. Share valuation-assume that you are the appointed financial advisor to revolution bikes. Write a report to the board, which will consist of the following:

A) Calculates a range of possible valuation based on the following three methods of share valuation:

1) Price/earnings ratio

2) Dividend growth valuation method

3) Discounted cash flow method (over a 10 year period)

 

B) Critically appraise the valuation methods used and contrast the differences in results arising from each of the valuations methods chosen in used in a.

 

 

2. Analyzing rise-comment on how the risk-adjusted, after-tax cost of capital rate of 12.0% referred to in the question might have been arrived at and provide critical analysis of three alternative methods available that allow for risk.

 

3. Financing- Critically discuss four methods for financing this acquisition.

 

4. Non-financial factors-evaluate five non-financial factors that management of revolution ltd. Will need to consider before acquiring racer bicycle co.

 

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Financial position statement of Racer Bicycle Company
fm
Non-current assets
296
Current assets
70
Goodwill
26
Total assets
392
Equity
Preferred share ( f 2)
+
20
Ordinary shares( f 1)
156
Reserves
75
251
7% bonds
96
Current liabilities
65
Total liabilities
392
+
Racer Bicycle Company statement of profit or loss extracts
f m
Profit before interest and tac
76
Interest payments
8.3
Profit before tax
67.7
Taxation
20.3
Distributable earnings
47.4
Other information:
Current ex-dividend share price
f 2.25
Latest dividend payment
16p
Past four year's dividend payments
13p, 13.5p, 14p, 15p
Racer's equity beta
1.15
Treasury bill yield
5%
Return on the market
12%

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