ASSIGNMENT THREE Recent financial information relating to Close Company, a stock market listed company, is as follows. $m Profit after tax (earnings) 66.6 Dividends 40.0 Statement of financial...

ASSIGNMENT THREE

Recent financial information relating to Close Company, a stock market listed company, is as follows.

                                                                    $m
Profit after tax (earnings)                            66.6
Dividends                                                    40.0

Statement of financial position information:

                                                                     $m                      $m
Non‐current assets                                                                  595
Current assets                                                                          125
                                                                                                 ––––
Total assets                                                                               720
                                                                                                 ––––
Equity:
Ordinary shares ($1 nominal)                                                    80
Reserves                                                                                    410
                                                                                                  ––––
                                                                                                  490
Non‐current liabilities:
6% Bank loan                                                                              40
8% Loan notes ($100 nominal)                                                   120
                                                                                                    ––––
                                                                                                    160
Current liabilities                                                                           70
                                                                                                    ––––
Total equity and liabilities                                                           720
                                                                                                    ––––
Financial analysts have forecasted that the dividends of Close Co. will grow in the future at a rate of 4% per year. This is slightly less than the forecast growth rate of the profit after tax (earnings) of the company, which is 5% per year. The finance director of Close Co. thinks that, considering the risk associated with expected earnings growth, an earnings yield of 11% per year can be used for valuation purposes.
Close Co. has a cost of equity of 10% per year and a before‐tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal value in six years’ time. Close Co pays tax at an annual rate of 30% per year and the ex‐dividend share price of the company is $8.50 per share.

Required:

(a) Calculate the value of Close Co using the following methods:

     (i) net asset value method;
     (ii) dividend growth model;
     (iii) earnings yield method.

(b) Discuss the weaknesses of the dividend growth model as a way of valuing a company and its shares.