Question

1.   Your investment club has the choice of investing in the following companies and have £10,000 to invest.

Alpha plc – a biotech company that is researching into the ageing process. Its main line of research is into the naturally occurring, but elusive and unstable chemical alphaomega. The company works out of leased laboratories and employs 20 eminent scientists and associated back up staff. After 8 years the company has yet to bring a product to the market. If alphaomega, now in stage 1 trials (of 3 stages) is successful then it will be a world first and can expect 20 years of a market monopoly earning clear profits of £10bn p.a. for that period. A look at the pharmaceutical industry in general shows that of the drugs in stage 1 trials only 1 in 200 have a chance of making it to the market. Alpha plc is offering 1m shares for £10 each with no promise of a dividend.

Beta plc – is a packaging company which originally manufactured cans for the drinks industry, but has now branched out into all types of food packaging. The company is well regarded and has factories in prime locations for countrywide distribution. Each factory is valued at £10m. For the past three years dividends have been paid out as follows: 30p in the first year, 40p in the second year, 50p in the third year. The current share price is £5.

How will you invest the money? Make a list of the areas where as an investor you would require further information using share valuation methods?

Answer 1

We would need a required Rate of Return for this calculation and the number of years for the trials to end.

However,Lets take a look at Beta Plc.

==> Average dividend paid out = (30+40+50)/3 = 40p

Expected Return = Average Dividend/Current Market Price = 40/500 = 8%

Or you can follow weighted average dividend = (50*3 + 40*2 + 30)/6 = 43.33 p ==> Return = 8.66%

or you can see the trend which indicates a 10p increment and consider expected dividend of 60p

==> Expected Return = 60/500 = 12%

Alpha Plc ,

Value of Company = Present Value of all Future Cash Flows

==> Value = (1/200)*10 Bn * PVAF(20 Years, Required Rate) * PVIF (Years of Trial, Rate)

==> Value = 50 Mn * PVAF (20,R) * PVIF (T, R) *

And for a million shares, value of each share = 50 * PVAF (20,R) * PVIF (T,R)

But the company is offering the shares for $10.

Assuming, it takes an year to trial and we only need a required rate of 1%

Value = 50* (18.05) * (0.99) = $724.89

That is a yield of 75 times.

And at a required rate of 8% ==> Value = $90.30

That is a yield of 9 times

At a require rate of 12% Value = 30.86 yielding 3.1 times or 310 %

So, we need more information as to Time the Revenues will start ( End of Trials), Required Rate.

Good Luck