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I have a question regarding Q26 and Q27 of BPP Sep/Dec 2019 Paper (pg 322 of BPP Kit).
For Q26, I am not sure why is the sector’s earning yield (0.1) used to calculate the value of Danoca Co ($2m / 0.1 = $20m).
Personally, I got $16.5m as my answer.
Earnings = EPS x No. of shares = $0.40 x 5m = $2m
Earnings / (EPS / Share price) = $2m / ($0.40 / $3.3) = $16.5m
If the P/E ratio of Danoca Co is higher than the average sector ratio then an acquisition by Phobis Co could result in improved financial performance of Danoca Co.
I don’t really understand why the statement above is false. Wouldn’t Danoca’s financial performance improve after acquisition? Or do I misunderstand the logic behind this statement?
Thank you so much in advance 🙂
You cannot use the existing share price ($3.30) as a basis for valuing the company.
An earnings yield valuation values the company such that the earnings yield (i.e. earnings/market value) is (in this case) 10% Given that the EPS is 40c, then for the earrings yield to be 10% the valuation per share has to be $4.
The PE ratio of a company is an indicator of the expected future growth. A higher that average PE ratio means that shareholders are expecting a growth rate higher than average for the sector.
Given that Danoca would therefore already be expected to grow faster than the average for the sector, we would not expect that being acquired by Phobis would make them grow even faster.