Finance Study Material and Solved Assignments

FINANCE

Question 1:
a.
i. P/E Ratio
P/E Ratio = Market value per share
Earnings per share
Market value per share = D
r−g
= 27 p
.16−.11 = 27 p / 0.05 = £540 per share
P/E Ratio = £ 540
38 p = 1,421 times
ii. Dividend growth model
P = D1
(k −g)
£540 = D1
(.16−.11)
D1 = £540 * .05 = 27p
b. Three problems associated with Dividend growth model
1. Must Pay Dividends
The main disadvantage of DDM is that it cannot be used to value stocks that do not generate
profits, with little attention being paid to potential capital gains from adding resources to the
stock. . DDM is based on the underlying suspicion that the main estimate of a stock is the rate of
return (ROI) it will lead to profits.
2. Many Assumptions Required
Another incompatibility of DDM is how useful valuation is used requires a number of
considerations that look into things, such as rate of development, required rate of return, and
level of costs. This includes how the DDM module accepts profits and revenues are matched.
3. Ignores Buybacks

A further analysis of the DDM is that it underestimates the effects of buying shares, effects that
could have a significant impact on the shares worth returning to investors. Stock purchase
oversight explains the problem with largely traditional DDM in valuing stock values.
Meanwhile, cost structures in different countries are making it more profitable to make a
purchase versus profit.
Best Method
The P/E method is perhaps the most commonly used valuation method in the stock brokerage
industry. It is best valuation method for shares because this method shows whether the stock is
undervalued or overvalued.
Question 2:
a. Calculate net present value of the proposal
Years
0 1 2 3 4 Total
Initial investment -£2,000,000
Sales revenue
£1,800,00
0 £1,980,000 £2,178,000 £2,395,800
Less: Production cost £750,000 £787,500 £826,875 £868,219
Gross profit
£1,050,00
0 £1,192,500 £1,351,125 £1,527,581
Less: Operating
expenses
Advertising £150,000 £150,000 £150,000
Quality control £200,000 £200,000 £200,000 £200,000
Net Profit before tax £700,000 £842,500 £1,001,125 £1,327,581
Less: Income
tax@19%p.a. £133,000 £160,075 £190,214 £252,240
Net Profit after tax £567,000 £682,425 £810,911 £1,075,341
Add: Scrap value £400,000
Cash inflows £567,000 £682,425 £810,911 £1,475,341
Present value
factor@10% 0.9091 0.8264 0.7513 0.6830
Discounted cash
inflows £515,455 £563,988 £609,250 £1,007,678 £2,696,369
Hence, the net present value of the above proposal is:
Net present value = Total discounted cash inflow – Initial investment