Ican 2021 Strategic Financial Management Question 1

Palemo Temidayo (PT) is a large engineering company listed on the stock market. The company is considering the purchase of Zinco, an unlisted company that produces a number of engineering components. The board of directors is concerned about the appropriate price to pay for Zinco. As a starting point, it has been decided to provide a range of valuations based on different industry recognised techniques. Summarised financial statements of Zinco Limited for the last two years are shown below: \( \begin{array}{lrr} \text{Statements of profit or loss for the years ended 30 June} & & \\ & 2020 & 2019 \\ & \text{₦'000} & \text{₦'000} \\ \text{Sales revenue} & \underline{112,400} & \underline{101,090} \\ \text{Opening profit before exceptional items} & 6,510 & 4,100 \\ \text{Exceptional items} & (10,025) & - \\ \text{Interest paid (net)} & \underline{(1,400)} & \underline{(890)} \\ \text{Profit/(Loss) before tax} & (4,915) & 3,210 \\ \text{Taxation} & \underline{(1,050)} & \underline{(890)} \\ \text{Profit/(Loss) after tax} & \underline{(5,965)} & \underline{2,320} \\ \text{Note: Dividend} & 1,000 & 500 \\ & & \\ \text{Statement of financial position as at 31 March (₦000)} & & \\ & 2020 & 2019 \\ \text{Non-current assets (net)} & & \\ \text{Tangible assets} & 27,150 & 25,240 \\ \text{Goodwill} & 850 & 1,000 \\ & & \\ \text{Current asset} & & \\ \text{Inventory} & 17,000 & 13,900 \\ & & \\ \text{Receivables} & 13,790 & 12,560 \\ \text{Cash and bank} & \underline{240} & \underline{240} \\ \text{Total assets} & \underline{\mathbf{59,030}} & \underline{\mathbf{52,940}} \\ & & \\ \text{Equity and liabilities} & & \\ \text{Call-up share capital (50 kobo par)} & 20,000 & 10,000 \\ \text{Retained profits} & 5,185 & 17,150 \\ \text{Other reserves} & \underline{6,245} & \underline{1,675} \\ \text{Total equity} & 31,430 & 28,825 \\ \text{Current liabilities -- payable} & \underline{27,600} & \underline{24,115} \\ & \underline{\mathbf{59,030}} & \underline{\mathbf{52,940}} \end{array} \) Additional information relating to Zinco: (i) If the acquisition succeeds, there will be revenue synergy leading to increase in annual sales revenue of Zinco of 25% for three years, and of 10% per year thereafter. (ii) Non-cash expenses, including depreciation, were N4,100,000 in 2020. (iii) Income tax rate is 30% p.a. (iv) Capital expenditure was N5 million in 2020, and is expected to grow at approximately the same rate as revenue. (v) Working capital, interest payments and non-cash expenses are expected to increase at the same rate as revenue. (vi) Zinco has a patent with current market value of N50million. This has not been included in the non-current assets. (vii) Operating profit is expected to be approximately 8% of revenue in 2021, and to remain at the same percentage in future years. (viii) Dividends are expected to grow at the same rate as revenue. (ix) The realisable value of inventory is expected to be 70% of its book value. (x) The estimated cost of equity is 12%. (xi) The average P/E ratio of listed companies of similar size of Zinco is 30:1. (xii) Average earnings growth in the industry is 6% per year. Required: