TSE International had been negotiating terms to acquire Yeats Valves and Controls Inc. In order for the acquisition to take place, TSE must perform an accurate valuation of the stock of TSE and YVC. Once the value of the stock is determined, a proper exchange ratio can be determined and an offer can be presented. Before we can utilize a valuation model we must first determine the cost of equity and the growth rate for each company.
Cost of equity was evaluated using the CAPM method measuring expected rate of return over a particular holding period. The US Treasury Yield of 30 year bonds and arithmetical average historical risk premium were used assuming that the investor risk aversion ...view middle of the document...
Market value measurements in the balance sheet can better capture an entity’s exposure to risk and increase its visibility in the balance sheet.
Despite the many advantages of the market value methodology there are a number of disadvantages. Due to its dependency to current market price, this methodology is only usable by publicly traded companies. Also smaller, less liquid stocks have lower transaction exchanges and therefore P/E ratios may be difficult to assess.
The total book value of equity of TSE International was $895,737,000. With 62,694,361 shares outstanding, price per share amounted to $14.29. The book value of YVC was $36,764,000. Price per share amounted to $25.53 per share with 1,440,000 shares outstanding. The book values calculated for each firm is lower than the market values.
Obtaining the data necessary to compute book value is generally readily available and is relatively simple to compute. Book value is based on historical costs, therefore it is the most accurate when determining past costs and provides management with a basis to create accurate forecasts.
However, book value methodology does not account for changes in prices. Because book value reflects historical costs it can be misleading when valuing older assets. Also book value methodology ignores intangible assets such as reputation, human capital, and investments in R&D.
Utilizing the DDM methodology we obtained an estimated per share value for TSE of $27.75 while the market value in 2000 is $21.98. The estimated value per share for YVC is $24.02 versus the market value in 2000 of $39.75. The DDM methodology is based on the idea that the company is worth the sum of discounted future cash flows. We used an average historical dividend growth rate assuming the steady growth rate in the future. We did not use a sustainable growth rate as we were not sure if the capital structure would stay the same after acquisition. It appeared that the growth was not that constant. TSE had a radical dividend growth rate that might have impacted the value estimation. On the other hand, TSE was less innovative compared to other competitors and might have looked less attractive to investors. DDM values might be misleading if the company is young and has a non-constant growth rate. It assumes that the company grows at a certain growth rate forever. YVC has a high growth rate of 13.57% that led to a high value per share. In reality it is impossible that the company will growth at this rate forever.
DDM methodology can be of great use in estimating share value of the mature companies that are experiencing stable growth and have a steady dividend policy. The model is relatively easy to use....