Discuss CIMA CIMAPRA19-F03-1 Exam Topic 2 Question 31

A large, quoted company that is all-equity financed is planning to acquire a smaller unquoted company that is also all-equity financed.

The acquiring company's directors are using the dividend valuation model to value the target company before making an offer.

Relevant data for the target company:

* Dividends paid in the last financial year $2 million

* Book value of net assets $15 million

* Shares in issue 1 million

The acquiring company's cost of capital is 10%.

Its directors believe they can improve the target company's performance in the long term.

They estimate there will be no growth in the first year of the acquisition butfrom year 2 onwards there will bea 4% growth each year in perpetuity.

What is the maximum price the acquiring company should offer for each of the shares in the target company?

A$33.33

B$34.67

C$32.78

D$15.00

Suggested Answer: A

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12 comments · newest first

Nadine 11 months ago

I disagree, $15 seems way too low for a share price.

Benedict 11 months ago

4% growth in perpetuity sounds solid!

Elenore 12 months ago

Wait, can they really improve performance that much?

Paz 12 months ago

I think they should go for option A, $33.33.

Rima 12 months ago

The target paid $2 million in dividends last year.

Irma 1 year ago

I feel like I might mix up the calculations. The dividends are $2 million, and with 1 million shares, that gives us $2 per share, but then we need to factor in the growth rate for the valuation.

Candra 1 year ago

I think the formula we need is the Gordon Growth Model. If I recall correctly, we should take the dividend and divide it by the cost of capital minus the growth rate.

Theola 1 year ago

I’m a bit unsure about the growth rate. We learned that if there's no growth in the first year, we should just use the dividend for that year, but then apply the growth rate from year two onwards.

Malinda 1 year ago

I remember we practiced a similar question about valuing a company using the dividend discount model. I think the key is to calculate the present value of future dividends.

Marion 1 year ago

I'm a little confused by the terminology, but I'll read the question carefully and try to eliminate the incorrect options.

Felix 1 year ago

Okay, let me think this through. I think the key is to identify the required questions that don't have default values. Maybe I can try clicking through and looking for any highlighted in red.

Selma 1 year ago

Okay, let me break this down. The question is asking which of the factors listed is NOT a reason for being uninsured. I'll need to evaluate each option carefully to determine the one that doesn't fit.

CIMAPRA19-F03-1 Exam - Topic 2 Question 31 Discussion