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Hi John
The question gives “earning before tax” of Hav Co $1,980m and Strand Co average $ 373m over 3 years.
But I am confused by the examiner’s answer, whether these are Before or After Interests amount.In calculation of premium based on excess earning of Strand,
“earning before tax” $373m is deducted by 869.3*0.2( capital employed*ROCE, which by definition should be Earnings BEFORE INTEREST and Tax) to arrive at pre-tax premium.Question1: So Is “earning before tax” of $373m actually Earnings BEFORE INTEREST and Tax of Strand Co? because we need to compare apple to apple right.
However, in calculation of premium based on P/E ratio,
Answer used ($1,980m * 0.8 + 397*0.8 +140) * PE ratio 14.5 = $29,603.2m Equity value of combined company.Question2: Does “earning before tax” of $1,980m and $397m here mean Earnings AFTER INTEREST and before tax? because the answer used them with PE ratio to get equity value.
Question3: If yes to both Q1&Q2, “earning before tax” is BEFORE interests in Q1 and AFTER interest in Q2, is this possible?
Thank you!
Although I understand the point you are making, the question specifically says that the the premium should be the after tax excess earnings over the average return on capital employed, and earnings before tax are automatically after interest (and, of course, we do not know what the interest is anyway because we are not given enough information). The question does not ask for a criticism of the method they are using – just to follow the instructions.
(Incidentally, the examiners answer says that it is similar to EVA. When the question was set, EVA was in the syllabus but it has since been removed from the syllabus.)As far as using PE ratios is concerned, the ratio is always applied to the earnings after interest and tax. Again the earnings gives as before tax must be already after interest.
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