Peter and Sandy own a medium-sized manufacturing firm, Max Security Ltd in Auckland. The company manufactures and installs security alarms for commercial and home security. Max Security Ltd has experienced rapid growth because of the new technology that improves the company’s monitoring efficiency. The company is owned equally by Peter and Sandy holding 250,000 shares each. If either wishes to sell the shares, the shares have to be offered first to the other shareholder at a discounted price. In 2017, Peter and Sandy have decided to value their holdings in the company for financial planning purposes. To accomplish this, they have gathered the following information about their main competitors.
EPS (Cents) DPS (Cents) Share Price ($) ROE (%) Required rate (%)
Hub Security Ltd -0.20 0.04 3.25 9.5 7.75
Reliable Security Plus 0.31 0.14 2.90 10.5 9.25
Kiwi Monitoring Ltd 0.16 0.16 12.10 10.25 9.00
Industry Average 0.24 0.18 7.05 10.5 8.75
Last year, Max Security Ltd had an EPS of $0.35, and Peter and Sandy were paid a dividend of $52,500 each. The company also had a return on equity of 18%. Peter and Sandy believe a required rate of return of 14% for the company is appropriate.
1. Calculate the share price of the company assuming the company continues its current growth rate (growth rate should be inferred from the data given) into the infinite period (adjust to 2 decimal places).
2. To verify their calculations, Peter and Sandy have hired Richard Hill, a consultant. Richard was previously an equity analyst, and he has a good understanding of the security Industry. Richard has examined the company’s financial statements as well as those of its competitors. Although Max Security Ltd currently has a technological advantage, Richard’s research indicates that Max Security’s competitors are investigating other methods to improve efficiency. Given this, Richard believes that Max Security’s technological advantage will last for only five years. After that period, the company’s growth is likely to slow down to the industry average, and so the industry average required return will be a more appropriate rate for valuation. Under Richard’s assumptions, what is the estimated share price?
3. What is the current industry average price-earnings ratio (PER)? Using Richard’s estimation in part (2) above, calculate Max Security’s price-earnings ratio. Comment on FOUR differences in PERs and explain why these differences may exist?
Price – earnings ratio is the price the market places on 1$ of a firm’s earnings.
4. After discussion with Richard, Peter and Sandy agree that they would like to increase the value of the company’s equity. Like many business owners, they want to retain control of the company and do not want to sell shares to outside investors. They also feel that the company’s debt is at a manageable level and do not want to borrow more money. What steps can they take to increase the share price? – justify each of your suggestions.