CHAPTER 16: PRINCIPLES OF VALUATION

SUGGESTED SOLUTIONS
SOLUTION TO MULTIPLE CHOICE QUESTIONS
16.1 (e) 16.6 (b)
16.2 (e) 16.7 (b)
16.3 (a) 16.8 (a)
16.4 (b) 16.9 (b)
16.5 (d) 16.10 (c)
END OF CHAPTER QUESTIONS

16.1
Net realisable value – the amount that would have been received after all costs commissions
and taxes on the sale of the vehicle.
Replacement cost – a valuation method, which ascribes the value as the cost of replacing the
item with another of identical age and condition.
Depreciated Historic cost – strictly not a value, but used a means of ascribing value by taking
the original cost and reducing it by a rate of depreciation which is considered appropriate to
the particular kind of asset, in this case a motor vehicle.
The Insurance company, in terms of their business objectives would prefer to pay out the
lowest value, which is likely to be the depreciated historic cost. As the owner, you are unlikely
to find that amount acceptable, as the replacement cost is likely to be the highest value and
also the only one which will enable you to replace what has been destroyed – exactly what
you insured against.

16.2
In a strange way, people tend to place values on items based on the cost to them (price). So if
one person pays more for an item of clothing than another person for a similar item does, it
may be incorrectly presumed that the more expensive item is more valuable. Value is an
elusive concept. Branded items are another good example – an item, because of its brand,
and resulting higher price, is considered to be of superior quality, but may not in fact be.
In finance it is important to first establish the value of something in Rand terms and then to
determine what the price of that item is. If the price is lower than the assigned value, it is worth
acquiring it. If the price is higher than the assigned value, it is not.
It is worth practising this concept, by looking at an item that you wish to purchase. Before
looking at the marked price, ask yourself the question “What would I be prepared to pay for
this” (In other words – what value does it have for me). Then find out the price and only
purchase it if the price is lower than the value that you assigned.

16.3
Local authorities value properties for the purpose of levying rates, payable for general services
such as maintenance of roads, garbage collection and so on. Rates are levied as a % of the
value placed on the property, using a valuation method established by the local authorities.
Some valuation techniques which could be used include:

 The price paid by the owner for the property - this is usually adjusted by an index for
inflation, based on the date when the property was purchased.

 The size of the plot, measured in metres2. or the square meterage of buildings on the
property or some combination of the two.

 Another, but less popular method is to base rates on the number of rooms in the home.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 1

16.4 TOPLINE LTD
Topline (Pty) Ltd Reported Net Profit = R150 000
Company A: Earning per Share = 50 cents Share Price = 510, so P/E = 10.2
Company B: Earning per Share = 80 cents Share Price = 795, so P/E = 9.9
Average P/E (Price/earnings ratio) = 10
So Topline Value on this valuation basis = 10 x R15 000
= R1 500 000

16.5 MAMAROMA LTD

JSE Market Return = 19%
Risk Free Rate = 11%
Mamaroma β = 1.2
Mamaroma Ltd Required Return = 11% + 1.2(19% - 11%)
= 11% + (1.2 x 8%)
= 11% + 9.6%
= 21%

16.6 GOVERNMENT BONDS

Coupon rate of bond = 7% (in perpetuity)
Bank overdraft rate = 18% (not relevant)
Required risk free rate = 14%
Value of Bond = R1 000 x (7%/14%)
= R5 000

16.7 FOTOKINO LTD

Nominal value of Preference Share = R20
Annual return on Preference Share = R2
Value of Preference Share = R2/15% (2/0.15)
= R13.33

16.8 SPS LTD

Annual Dividend = R6
Share Price = RR90
Required return (yield) = 6/90
= 6.6% (very low)

16.9 LONA TRADING

Cash Dividend = R1.50
Required Return = 16%
Value of share = R1.50/16% (1.50/.16)
= R9.38

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 2

16.10 OLIN LTD
Next dividend (D1) = R4.20
Price (Po) = R38
Growth rate (g) = 6%
Required rate (Vs) = ( D 1 / Vs ) + g
= (R4.20 / R38) + 6%
= 11% + 6%
= 17%

16.11 GOVERNMENT BOND

Coupon Rate = R8 (perpetuity)
Coupon = R1 200
Market rate (required yield) = 14%
Years to maturity = 3
Present Value = (R1200x[PVA#14%#3years])+(R10000xPV#14%#3years])
= (R1 200 x 2.3216) + (R10 000 x 0.6750)
= R2 285.92 + R67 500
= R70 285.92

16.12 GOVERNMENT BOND

Coupon = R8 (perpetuity)
Required rate (yield) = 11%
Value of the Bond = R8/11%
= R72.72

16.13 UNIVERSITY ENDOWNMENT

Fee (Required Income) = R15 000
Expected growth (inflation) = 6%
Yield (return) = 16%
Amount required for endowment = R15 000 / (16% - 6%)
= R150 000
Note: In the first year the yield will be 16/150 000 = R24 000. Only R15 000 us paid out, the balance
re-invested.
So in the second year, the yield will be 16/159 000 = R24 440. Only R15 900 (increase as a result of
inflation) is paid out, the balance of R9 540 is re-invested….and so on.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 3

16.14 REGAL LTD
(a) Value of a share today
YEAR END 0 [NOW] 1 2 3 4 5 6
Growth rate 0% 0% 6% 6% 8% in perpetuity
Expected Dividend (cents) 20.0000 20.0000 21.2000 22.4720 24.2698
Value (based on pertpetual growth)
P4 = D5 / (k - g) = 24.2698 / 16% - 8% 303.3720 (V = D1/(Rs - g)
Cash Flows 20.0000 20.0000 21.2000 325.8440
PV factor at 16% 0.8621 0.7432 0.6407 0.5523
Discounted (PV) cash flows 17.2420 14.8640 13.5828 179.9636
Present Value [Sum of discounted cash flows] 225.65
Value of a share today R 2.26

(b) Value of a share - beginning of 3rd year

YEAR END 2 [NOW] 3 4
Expected Dividend (cents) 21.2000 22.4720
Value (based on pertpetual growth) 303.3720
Cash Flows 21.2000 325.8440
PV factor at 16% 0.8621 0.7432
Discounted (PV) cash flows 18.2765 242.1673
Present Value [Sum of discounted cash flows] 260.44
Value of a share - beginning of 3rd year R 2.60

(c ) Value of a share - beginning of 4th year

YEAR END 3 [NOW] 4
Expected Dividend (cents) 22.4720
Value (based on pertpetual growth) 303.3720
Cash Flows 325.8440
PV factor at 16% 0.8621
Discounted (PV) cash flows 280.9101
Present Value [Sum of discounted cash flows] 280.91
Value of a share - beginning of 3rd year R 2.81

Capital Gain during year 3 [also a dividend of 21.2cents] R 0.21 [R2.81 - R2.60]

16.15 KWALIPRINT (PTY) LTD

(a) Latest Earnings per Share = 95 cents
Average Price to Earnings ratio = 7.6
Value per share = 95 cents x 7.6
= R7.22
Value of the business = 900 000 x R7.22
= R6 498 000
(b) This method is clearly very rough and ready, but offers some indication of the value of the
share. It depends to a significant extent on the company being valued, having very similar
qualities and characteristics as the company whose price earnings ratio is being used as the
proxy for valuation.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 4

16.16 EX AND ZEE
(a) The Capital Asset Pricing Model was developed on a number of assumptions about
market behaviour. Probably the most significant for practical purposes is that the market (in
South Africa the JSE) is efficient, that is that prices react immediately and in the right direction
to all publicly available information.
The model holds that there are two types of risk which investors take on when buying shares.
The first is the risk of the company (that it may do badly and therefore destroy wealth). The
second is the risk of the market as a whole (which moves in cycles based on issues in world
and national economies). However, through diversification (holding a portfolio with a number
of different shares - say around 15 to 20), all company risk is diversified away (some will do
well and others not so well, but on average, the portfolio will do OK). For this reason, the
market does not reward investors for risk that they take by not diversifying and holding a
portfolio.
Market risk, on the other hand, cannot be diversified away, and it is therefore this risk which is
rewarded. Market risk is measured by Beta (β), which measures the relative volatility of a
share to the market as a whole. The market beta (slope of the regression line) is, by definition,
and by eye-balling a graph, equal to 1. Shares which are more volatile (risky) than the market
as a whole have a beta greater than one, while less volatile shares have a beta of less than
one. On this basis the required rate of return (that which an investor must be expecting to
receive before being prepared to purchase the share), is determine as follows:
Required return = Risk free rate + β of the share x the Market premium
The market premium is the average return of the market less the Risk free rate.
(b) The beta of a share is determined by statistically measuring its movement (return) against the
returns of the share market as a whole, usually on a weekly basis over a long period of 3 to 5
years. When plotted on a graph, the steepness of the line is the beta. The market return
measured against the market return obviously gives a 45 degree angle - hence a beta of 1.
Each share may have a steeper line (beta greater than 1) being more volatile, or vice versa.
(c ) Required return Ex = 12% +( 0.9 x 9%) = 20.1%
Required return Zee = 12% +( 1.5 x 9%) = 25.5%

16.17 EM AND EM
(a) Growth models are based on the solid theoretical basis of discounting future cash flows at
required rates of return. There is also the practical expectation that good companies are
expected to show growth over time. The most significant variable however is the actual growth
rate and this is clearly difficult to accurately predict. Moreover the expectation of steady growth
in economies which can be volatile is a limitation of the model.
(b) Vm = (0.95 x 1.08) / (20% - 8%) = R8.55
Vn = (1.05 x 1.08) / (20% - 4%) = R6.83

16.18 HOFINGER LTD

(a) Issue A: 14% Redeemable Preference share of R2, 5 years to maturity, Maturity value R2.20
Value = 28cents x PVA#11%#5years + 220cents x PV#11%#5years
= 28 x 3.6959 + 220 x .5935 = 103.49 + 130.57 = R2.34
Issue B: 7% Preference share of R5, 4 years to option date, Option value 90 cents (450/5)
Value = 35cents x PVA#15%#4years + 500cents x PV#15%#4years
= 35 x 2.8550 + 500 x .5718 = 99.93 + 285.90 = R3.86
Will not exercise the option
Issue B: 4% Participating Preference share of R1, Dividend 4 cents +40% O/S dividend
Value in perpetuity of the O/S dividend = (35c x 40%)/(13% - 5%) = R1.75
Value in perpetuity of the P/S dividend = 4 cents/13% = R0.31R
Value of both cash flows to P/S holder = R2.06
(b) Value of an ordinary share = 35cents/(13% - 5%) = R4.38
[This presumes that Ordinary shareholders require a 13% return - probably this should be higher]

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 5

16.19 KLAGTES LTD

1 YEAR 2 YEARS 3 YEARS

(a) CLASSIC 8% DEBENTURE NOW FROM FROM FROM
NOW NOW NOW
Cash flow from Interest [8%] R 0.00 R 8.00 R 8.00 R 8.00
Cash flow at Maturity R 110.00
Cash Flows to be received R8 R8 R 118
Present Value factor AT 10% 1.0000 0.9091 0.8264 0.7513
Present Value of each Cash Flow R 7.27 R 6.61 R 88.66
VALUE OF THE DEBENTURE R 102.54

1 YEAR 2 YEARS 3 YEARS 4 YEARS

5 YEARS
NOVEL 16% DEBENTURE NOW FROM FROM FROM FROM
FROM NOW
NOW NOW NOW NOW
Cash flow from Interest [16%] R 0.00 R 1,600.00 R 1,600.00 R 1,600.00 R 1,600.00 R 1,600.00
Cash flow at Maturity R 8,000.00
Cash Flows to be received R 1,600 R 1,600 R 1,600 R 1,600 R 9,600
Present Value factor AT 11% 1.0000 0.9009 0.8116 0.7312 0.6587 0.5935
Present Value of each Cash Flow R 1,441.44 R 1,298.60 R 1,169.91 R 1,053.97 R 5,697.13
VALUE OF THE DEBENTURE R 10,661.05

1 YEAR 2 YEARS 3 YEARS

(b) CLASSIC 8% DEBENTURE NOW FROM FROM FROM
NOW NOW NOW
Cash flow from Interest [8%] R 0.00 R 8.00 R 8.00 R 8.00
Cash flow at Maturity R 110.00
Cash Flows to be received R8 R8 R 118
Present Value factor AT 12% 1.0000 0.8929 0.7972 0.7118
Present Value of each Cash Flow R 7.14 R 6.38 R 83.99
VALUE OF THE DEBENTURE R 97.51

1 YEAR 2 YEARS 3 YEARS 4 YEARS

5 YEARS
(b) NOVEL 16% DEBENTURE NOW FROM FROM FROM FROM
FROM NOW
NOW NOW NOW NOW
Cash flow from Interest [16%] R 0.00 R 1,600.00 R 1,600.00 R 1,600.00 R 1,600.00 R 1,600.00
Cash flow at Maturity R 8,000.00
Cash Flows to be received R 1,600 R 1,600 R 1,600 R 1,600 R 9,600
Present Value factor AT 13% 1.0000 0.8850 0.7831 0.6931 0.6133 0.5428
Present Value of each Cash Flow R 1,415.93 R 1,253.03 R 1,108.88 R 981.31 R 5,210.50
VALUE OF THE DEBENTURE R 9,969.65

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 6

16.20 10% RSA 187 GOVERNMENT BOND
(a) 1 YEAR 2 YEARS 3 YEARS 4 YEARS 5 YEARS 6 YEARS 7 YEARS
& RSA 187 NOW FROM FROM FROM FROM FROM FROM FROM
(b) NOW NOW NOW NOW NOW NOW NOW

Cash flow from Coupon [10%] R 0 R 10,000 R 10,000 R 10,000 R 10,000 R 10,000 R 10,000 R 10,000
Cash flow at Maturity R 100,000
Present Value factor AT 12% 1.0000 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 0.4523
Present Value of each Cash Flow R 8,929 R 7,972 R 7,118 R 6,355 R 5,674 R 5,066 R 49,758
PURCHASE PRICE R 90,872

1 YEAR 2 YEARS 3 YEARS 4 YEARS 5 YEARS 6 YEARS

(c) RSA 187 NOW FROM FROM FROM FROM FROM FROM
NOW NOW NOW NOW NOW NOW

Cash flow from Coupon [10%] R 0 R 10,000 R 10,000 R 10,000 R 10,000 R 10,000 R 10,000
Cash flow at Maturity R 100,000
Present Value factor AT 12% 1.0000 0.9174 0.8417 0.7722 0.7084 0.6499 0.5963
Present Value of each Cash Flow R 9,174 R 8,417 R 7,722 R 7,084 R 6,499 R 65,589
SELLING PRICE R 104,486

Selling Price R 104,486

Less Cost Price R 90,872
Capital Gain R 13,613
Add Coupon received R 10,000
TOTAL HOLDING GAIN R 23,613

(d) During the holding period, one coupon payment of R10 000 was received. In addition,
because the market yield (return required by investors in bonds) dropped, investors, satisfied
with a lower yield, are prepared to pay a higher price for the constant annual yield of R10 000.
As a result, a capital gain is made during the holding period.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 7

16.21 GOVERNMENT BOND OF R100 000 14% COUPON

1 YEAR 2 YEARS 3 YEARS 4 YEARS 5 YEARS 6 YEARS

(a) Government Bond 14% NOW FROM FROM FROM FROM FROM FROM
NOW NOW NOW NOW NOW NOW

Cash flow from Coupon [14%] R 0 R 14,000 R 14,000 R 14,000 R 14,000 R 14,000 R 14,000
Cash flow at Maturity R 100,000
Cash flows to be received R 14,000 R 14,000 R 14,000 R 14,000 R 14,000 R 114,000
Present Value factor AT 14% 1.0000 0.8772 0.7695 0.6750 0.5921 0.5194 0.4556
Present Value of each Cash Flow R 12,281 R 10,773 R 9,450 R 8,289 R 7,271 R 51,937
VALUE OF THE BOND R 100,000

1 YEAR 2 YEARS 3 YEARS 4 YEARS

(b) Government Bond 14% NOW FROM FROM FROM FROM
NOW NOW NOW NOW

Cash flow from Coupon [14%] R 0 R 14,000 R 14,000 R 14,000 R 14,000

Cash flow at Maturity R 100,000
Cash flows to be received R 14,000 R 14,000 R 14,000 R 114,000
Present Value factor AT 14% 1.0000 0.8772 0.7695 0.6750 0.5921
Present Value of each Cash Flow R 12,281 R 10,773 R 9,450 R 67,497
VALUE OF THE BOND R 100,000

1 YEAR 2 YEARS 3 YEARS 4 YEARS

(c ) Government Bond 14% NOW FROM FROM FROM FROM
NOW NOW NOW NOW

Cash flow from Coupon [14%] R 0 R 14,000 R 14,000 R 14,000 R 14,000

Cash flow at Maturity R 100,000
Cash flows to be received R 14,000 R 14,000 R 14,000 R 114,000
Present Value factor AT 12% 1.0000 0.8929 0.7972 0.7118 0.6355
Present Value of each Cash Flow R 12,500 R 11,161 R 9,965 R 72,449
VALUE OF THE BOND R 106,075

1 YEAR 2 YEARS 3 YEARS 4 YEARS 5 YEARS 6 YEARS

(d) Government Bond 14% NOW FROM FROM FROM FROM FROM FROM
NOW NOW NOW NOW NOW NOW

Cash flow from Coupon [14%] R 0 R 14,000 R 14,000 R 14,000 R 14,000 R 14,000 R 14,000
Cash flow at Maturity R 100,000
Cash flows to be received R 14,000 R 14,000 R 14,000 R 14,000 R 14,000 R 114,000
Present Value factor AT 12% 1.0000 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066
Present Value of each Cash Flow R 12,500 R 11,161 R 9,965 R 8,897 R 7,944 R 57,756
VALUE OF THE BOND R 108,223

1 YEAR 2 YEARS 3 YEARS 4 YEARS 5 YEARS 6 YEARS

(e) Government Bond 14% NOW FROM FROM FROM FROM FROM FROM
NOW NOW NOW NOW NOW NOW

Cash flow from Coupon [14%] R 0 R 14,000 R 14,000 R 14,000 R 14,000 R 14,000 R 14,000
Cash flow at Maturity R 100,000
Cash flows to be received R 14,000 R 14,000 R 14,000 R 14,000 R 14,000 R 114,000
Present Value factor AT 10% 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645
Present Value of each Cash Flow R 12,727 R 11,570 R 10,518 R 9,562 R 8,693 R 64,350
VALUE OF THE BOND R 117,421

1 YEAR 2 YEARS 3 YEARS 4 YEARS

(f) Government Bond 14% NOW FROM FROM FROM FROM
NOW NOW NOW NOW

Cash flow from Coupon [14%] R 0 R 14,000 R 14,000 R 14,000 R 14,000

Cash flow at Maturity R 100,000
Cash flows to be received R 14,000 R 14,000 R 14,000 R 114,000
Present Value factor AT 10% 1.0000 0.9091 0.8264 0.7513 0.6830
Present Value of each Cash Flow R 12,727 R 11,570 R 10,518 R 77,864
VALUE OF THE BOND R 112,679
(g) When the market rate moves down, the value of the bond increases. The longer the term to
maturity, the more volatile the change (bigger changes in value when the rate changes).

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 8

16.22 THE WATERFRONT WOOD COMPANY LTD

(a) Value of a share today

YEAR END 0 [NOW] 1 2 3 4
Growth rate 30% 30% 30% 7% in perpetuity
Expected Dividend (cents) 150 195 254 330 353
Value (based on pertpetual growth)
(b) P3 = D4 / (k - g) = 353/ (23% - 7%) 2,204 (V = D1/(Rs - g)
(c) Cash Flows (cents) 195 254 2,533
PV factor at 23% 0.8130 0.6610 0.5374
Discounted (PV) cash flows (cents) 159 168 1,361
Present Value [Sum of discounted cash flows] 1687.56
Value of a share today R 16.88

16.23 BLUEGUM HILLS HOTELS LTD

(a) Value of a share today

YEAR END 0 [NOW] 1 2 3 4 5
Growth rate 20% 20% 8% 8% 8% in perpetuity
Expected Dividend (cents) 300 360 389 420 453
Value (based on pertpetual growth)
(b) P2 = D3 / (k - g) = 353/ (22% - 8%) 2,777 (V = D1/(Rs - g)
(c) Cash Flows (cents) 300 3,137
PV factor at 22% 0.8197 0.6719
Discounted (PV) cash flows (cents) 246 2,108
Present Value [Sum of discounted cash flows] 2353.76
Value of a share today R 23.54

16.24
(a) Cost of Equity (CAPM) = 12% + (1.3 x 8) = 12% + 10.4% = 22.4% (say 22%)
(b) Value of a share (using 22% as calculated in a above)

20.4
YEAR END 20.5 20.6 20.7 20.8 20.9 20.1
[NOW]
Growth rate 10% 10% 10% 10% 10% 8% in perpetuity
Expected Dividend (cents) 85.0 93.5 102.9 113.1 124.4 136.9 147.8
Value (based on pertpetual growth)
P(end of 20.9)= D(20.10)5 / (k - g) = 147.8 / 22% - 8% 1056.0 (V = D1/(Rs - g)
Cash Flows 93.5 102.9 113.1 124.4 1192.9
PV factor at 22% 0.8197 0.6719 0.5507 0.4514 0.3700
Discounted (PV) cash flows 76.6 69.1 62.3 56.2 441.4
Present Value [Sum of discounted cash flows] 705.61
Value of a share today R 7.06

(c) There are many alternative valuation methods which can be used. The growth model is
commonly used, but relies on stable estimates of a volatile future. Management should apply
a number of different valuation models, each of which should be compared against the net
asset value of the company's realisable tangible assets.

© FLYNN D K: UNDERSTANDING FINANCE AND ACOUNTING: 2ND EDITION: SUGGESTED SOLUTIONS 9