(a) The directors of Oscar plc are trying to estimate its value under its current strategy using a Shareholder Value Analysis framework. The last reported annual sales of Oscar plc were £30 million.
The key value drivers are estimated as follows:
Sales growth rate
|
7%
|
Operating profit margin (before tax)
|
10%
|
Corporation tax
|
30%
|
Fixed capital investment
|
15% of sales growth
|
Working capital investment
|
9% of sales growth
|
Planning period
|
6 years
|
Weighted average cost of capital
|
13%
|
Depreciation is currently charged on a reducing balance basis. The most recent charge was £0.5 m. This is
expected to remain constant over the next few years. All depreciation is tax-allowable.
The dividend pay-out ratio is 20%.
Assume marketable securities held are £2.5 m, and debt (in the form of a bank loan) is £6 m (interest payable is at the rate of 8.33% p.a.).
Required
Calculate the overall company (or enterprise) value, and the shareholder value.
(Clearly state any assumptions that you make.)
(b) The market value of Oscar’s equity is £25 m (lower than the directors’ estimate of value), and also below the book value of net assets of £50 m.
Several directors argue that Oscar is undervalued by the stock market, and are wondering how to improve the firm’s stock market rating.
Required
Suggest possible reasons for this apparent undervaluation, and evaluate suitable financial policies that Oscar’s directors might adopt to enhance its value.