Financial Management: Valuation Techniques and Investment Appraisal

FINANCIAL
MANAGEMENT

TABLE OF CONTENTS
QUESTION 2...................................................................................................................................1
a) Price Earning Ratio..................................................................................................................1
b) Dividend Valuation Method....................................................................................................1
c) Discounted cash flow method..................................................................................................2
d) Problems associated with the valuation techniques.................................................................3
QUESTION 3...................................................................................................................................7
1. Application of various investment appraisal techniques.........................................................7
2. Evaluating benefits and limitation of investment appraisal tool ............................................9
REFERENCES..............................................................................................................................13

QUESTION 2
a) Price Earning Ratio
P/E Ratio = Market Capitalisation /
Earnings after tax and preference
dividend
Market capitalisation = Market Price *
No. of shares
Market Price 2.05
No of shares 147
Market capitalisation = 301.35
Earnings after tax 40.4
Preference dividends = 0
Earnings after tax and preference dividends
= 40.4
P/E ratio 7.46
Market price = P/E * EPS
P/E 7.46
EPS = 40.4 / 147 = 0.2748
Market Price
(7.46 * 0.2748) 2.05
Alternatively
P/E = Market price / EPS 7.46
(2.05 / 0.2748)
b) Dividend Valuation Method
Return on Equity 11.6
Re = Rf + (Rm – Rf) * Beta
5 + (11 – 5 ) * 1.1
Dividend Valuation method
Price = D1 / (Ke – g)
D1 0.1326
(0.13 +(0.13*2%))
1

Ke 11.60%
g 2.00%
Price = D1 / (Ke – g) 1.38
(0.1326 / (0.116 – 0.02)
c) Discounted cash flow method
Discounted cash flow method
WACC
Cost of equity 11.60%
Cost of debt 5.60%
(7% * (1-tax rate)
Weights
Equity 0.67
(147 / 219)
Debt 0.33
(72 / 219)
WACC 9.63%
(11.60% * 0.67)+(5.60% * 0.33)
Year
Cash flow
@g=2%
Discount @
9.63%
Present
value
1 40.4 0.912 36.86
2 41.2 0.832 34.31
3 42.0 0.760 31.93
4 42.9 0.693 29.71
5 43.7 0.632 27.65
6 44.6 0.577 25.73
Discounted cash flow = FCFF / (Kc – g)
FCFF 5 27.65
Present value of FCFF 6 25.73
44.6 / (1.096)^6
Kc 9.63%
g 2.00%
Value of the firm 338.5
Alternatively
2