NORTHWEST MARINE SERVICES PRIVATE LIMITED Case Solution & Answer

NORTHWEST MARINE SERVICES PRIVATE LIMITED Case Solution

Question 2 (3 marks)

Part A (1 mark): Northwest Marine Services has issued a dividend of $0.38 per share for the past five years. As part of your advice to the Mitchell family, you have been asked to determine what a ‘fair’ price for company shares would be before listing on the ASX. You are told that in total the Mitchell family holds 3 million shares, and required rates of return for companies in the same industry are approximately 7% per annum. Despite the possibility of listing, you are told to assume that the dividend will remain constant in the future.

Required: Calculate a ‘fair’ share price based on the information above.

The fair share price of the company with the help of the required rate of return as well as the value of dividend per share is calculated as below:

Constant Dividend	Div	 $                                      0.38
Required Rate of Return	K	7%
Fair Price of the share	v	?
Fair Price of the Share	Â	 $                                      5.43

The fair price of the share for the company with the dividend of $0.38 per share as well as the required rate of return of 7% is $5.43.

Part B (2 marks): Northwest Marine Services successfully lists on the ASX, and in approximately one year trade at $5.16 per share, with a recent dividend of $0.38. A member of the Mitchell family contacts you and explains that they would like to repurchase some shares in the now-listed company. They ask you if $5.16 per share is a ‘fair’ price, or if the company is potentially overvalued. You check the financial press and note that required rates of return on similar companies are 12% per annum, with a market-consensus dividend growth rate of around 4% per annum.

Required: Calculate a ‘fair’ share price based on the information above. Explain why shares in Northwest Marine Services are either under or over-valued based on your calculations.

In order to calculate the revised fair share price when with the help of analysis, it is revealed that the required rate of return has increased from 7% to 12%, whereas the growth rate for the stock is analyzed to be 4% per annum, the following calculations are made:

Dividend	Div	 $                                      0.38
Required Rate of Return	k	12%
Fair Price of the share	v	?
Growth Rate	g	4%
Fair Share Price		V = Div/(k – g)
	v	 $                                      4.75

The fair share price in this case with the help of 12% required rate of return and 4% growth rate is $4.75. With the help of the calculation, it is revealed that the share price is over-valued in the market as the price prevailing in the market is $5.16 per share, whereas the calculated value is just $4.75 per share. The prime reason behind this overvaluation is the increase of required rate of return from 7% per annum to 12% per annum because of the increased risk that is associated in getting the return from the listed company. Moreover, it is overvalued due to the perception of the shareholders that the stock will perform better in the future. There could be some other reasons of over valuation as well but that cannot be calculated here because of any data.

Question 3 (5 marks) Part A (3 marks): During the listing process, most of the cash flow of Northwest Marine Services will be devoted to administrative and legal costs, leaving a shortfall for day-to-day operations. The finance manager informs you that she expects the company to owe their largest supplier $3million by the beginning of April. You are asked to find an appropriate commercial bill to finance the payment to this creditor……………

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