1) From the above case study provided, identify the possible corporate valuation

approaches and estimate the fair values of Xepa-Osmond Pharmacy ltd using the
approaches.
Earnings Multiple Approach
Formula used:
Fair value per share = Industry Average P/ E ratio × Earnings per Share
Where:
P / E ratio= Price / Earnings x ratio
Earnings per share = Profit / Number of Ordinary Shares

By calculating their mean, the industry average P/B ratio can be derived as shown below.

= 10.5+11.5+12.5+6.8+8.3+9.7 / 6

= 59.3 / 6

= 9.883333333 ≈ 9.883

Moving on, the earnings per share is calculated:

Industry average P/E ratio =

Earnings per share = 3 , 123,100 / 2,000,000

= 1.56155 ≈ 1.56

To find the fair value of share, the values are substituted into the formula as shown below.

Fair value per share = 9.883 × 1.56

= 15.41748 ≈ £15.42
Sales Multiple Approach

Formula used :

Fair value per share=Industry Average P/S ratio × Sales per Share

P/S ratio = price/sales x ratio = 1/ (sales/market value)

Sales per share = sales/number of ordinary shares

By calculating the mean of the companies’ P/S ratios, we can obtain the industry average P/S
ratio as follow:

= 0.5882+0.6250+0.6667+0.5263+0.4348+0.7143 / 6
= 3.5553/ 6
= 0.59255 ≈ 0.5926

Next, we calculate the sales per share:

Industry average P/D ratio =

Sales per share
= 45,924,800 / 2,000,000
=22.9624 ≈ 22.96
Lastly, we substitute both of the values into the formula to get the fair value per share. Fair
value per share
= 0.5926 × 22.96
= 13.606096 ≈ 13.61
Net Asset Value Approach

Formula used:

Fair Value per Share = Net Asset Value / Number of Ordinary Shares

Where:
Net Asset Value = Market Value of Total Assets – Total Liabilities

Market Value of Total Assets

= Premises + Plant and equipment + Motor vans at cost + ‘Inventories +Trade receivables +
Cash at bank
= 31,500,000 + 3,948,100 + 2,290,200 + 1,346,700 + ‘1,490,600 + 2,012,900
= 42,588,500

Total Liabilities = Non-current liabilities + current liabilities = 7,000,000 + 4,357,200

= 11,357,200

Net Asset Value = 42,588,500 - 11,357,200 = 31,231,300

From the statement of financial position (balance sheet) as at 31 January Year 5, we know
that the number of ordinary shares = 2,000,000.

Hence,
Fair value per share = 31,231,300 2,000,000
= 15.61565 ≈ £15.62

2) Select 3 of the approaches in a) above and discuss the advantages and disadvantages
in estimating Xepa-Osmond pharmacy limited.

The first approach we choose is the free cash flow method (FCF). FCF measures a company’s
financial performance. It shows how much cash a company can generate by deducting assets
from the operating cash flow ("Free Cash Flow (FCF) - Most Important Metric in Finance &
Valuation", n.d.). The advantage of FCF is that the intrinsic value of the equity can be
justified. FCF allows the company to have a close and accurate intrinsic equity value, so the
company can have a more accurate decision. Moreover, FCF can help the company’s
management to know the real value of their company, whether it is under- or over-valued in
the current market. One of the limitation for FCF is that it does not benefit for the long-term
investing due to there will be many uncertainties in the future. This will cause the decisions
made by the company’s management to be not accurate. In addition, FCF will work only
when the company operating under 100% transparency. If not there will be many questions
about the information which can affect the FCF and many uncertainties will occur when the
company using this method (Gaille, n.d.).

The second approach is the market value approach. This approach is a valuation method that
used to determine the value of the company, intangible assets or security by considering the
market price of comparable assets or company. The advantages of this method are that it uses
data that is real and public. So, the company can make a decision which is more closely to the
current and real economic condition. Besides, this valuation method is not dependent on the
subjective forecasts, which means the decision made is based on the data but not just rely on
the judgement and estimation of the company. On the other hand, by using market value
approach it is hard for the company to identify comparable companies or there may be lack of
sufficient number of comparable companies in the industry. Therefore, this might raise
questions that is the data used by the company has a good quality and how much data is
available. In addition, this method is less flexible compare to the other method ("Market
Approach - Methods, Uses, Advantages and Disadvantages", n.d.).

The third approach is the earnings multiplier or so call price-to-earnings (P/E) ratio. This
method determine the company’s current share price based on the company’s EPS ("Earnings
Multiplier", 2018). One of the biggest advantage of this method is that it is easy to use and
understand, even for those who have not exposed to financial education.

Besides, the current P/E ratio can be compared to the company past performance. For
instance, when the company’s EPS growth, but the P/E ratio keep constant, this means that
the growth price does not match the growth of the profitability of shares, which we can
conclude that the company is undervalue (Csanad, 2013). During inflation, P/E ratio tend to
be lower because inventory and depreciation costs are often undervalued on the balance sheet
as the replacement costs of goods and equipment rise with the overall price level. Moreover,
there are two guidelines use to determine the earnings of a company in each country such as
Generally Accepted Accounting Principles (GAAP) and International Financial Reporting
Standards (IFRS). Thus, EPS will be different when the company using different guideline to
determine earnings. So, it is hard to compare the P/E ratio when each company using
different guideline ("P/E Ratio: Problems With The P/E", 2017).

3) In your justification,which TWO approaches are the mostsuitable in estimating the

fair prices of Xepa-Osmond Pharmacy Ltd and which TWO approaches are the least
suitable. Why?

In our justification, free cash flow method (FCF) and market value method are the most
suitable valuating method in estimating the fair price of Xepa-Osmond Pharmacy Ltd.

The reason for choosing FCF method as one of the most suitable method in estimating fair
prices of the company is because FCF provides better concept of the level of earnings that
company can actually use after meeting their interest, tax and other commitments
(THANGAVELU, 2018). Besides, FCF take into account of different assumptions such as
future working capital needs, expected sales revenue and operating profit margins, that
typically provided by the company’s management and appraisers after conducted a
reasonableness tests. Moreover, terminal value and cost of capital are also included in the
calculation and the cost of capital used in calculation is estimated after considering the risk of
the company and time value of money ("Pros and Cons of Income, Market-based and Asset
Based Valuation Approaches", 2017). Therefore, we can believe that the FCF method will
provide a more accurate result and will be more suitable in estimating the fair price of the
Xepa-Osmond Pharmacy Ltd.

Followed by is the market value method. Market value method determining the value of the
company’s assets through the price of comparable assets in similar industries or public listed
companies ("Market Approach - Methods, Uses, Advantages and Disadvantages", n.d.).
Through this approach the fair price of the Xepa-Osmond Pharmacy Ltd is compare to the
guideline companies, so the management can determine whether the fair price of the
company is undervalued or overvalued. Since, there is a data of guideline companies used in
estimating the market value method, we can say that the estimation is more reality and does
not depend on the subjective predictions. Furthermore, using the latest market pricing can
reflect the current market condition and industry outlook. Using publicly- traded prices or
guideline companies price, we can know the actual prices that investors willing to pay for the
company which can be the alternative investment for the guideline company ("Market
Approach | Income Approach | Ohio Business Valuations", 2016). Thus, through this
approach we can the estimate the fair price of Xepa-Osmond more accurate and real as there
is a guideline used to compare.

On the other hand, we think that book value per share and dividend multiple are the least
suitable approaches to estimate the fair price of Xepa-Osmond Pharmacy Ltd.
Book value per share is used to compare the ratio of the company’s stockholders’ equity to
the number of shares outstanding and this is the amount of shareholder will receive when the
company is dissolves ("What is Book Value Per Share (BVPS)? - Definition | Meaning |
Example", n.d.). By using book value per share tends to undervalue some assets. Book value
per share do not take into account of the value for intangible asset, such as pattern and
goodwill (qmarks, 2010). This is because it is hard to put a cash value for these assets, as it
takes a long time to grow. This will be less useful for the company that with large amount of
intangible assets, and Xepa-Osmond Pharmacy Ltd is a pharmaceutical company which has a
large amount of intangible asset. Besides, the book value per share is calculate by using the
historical value in the balance sheet which will results in an inaccurate measurement for the
company’s fair price ("Price/Book Value Ratio", n.d.), and it is not directly related to the
market value of the company. Originally, it is the accounting value and is subject to the
discretion of management in accounting policies (PEAVLER, 2018). Thus, by using this
approach in estimating the fair price of the company seem to be not accurate and is not a
forward-looking method. In addition, it might mislead the company’s management and
investors in making decisions.
Dividend multiple is another approach which is least suitable in estimating the fair price of
Xepa-Osmond Pharmacy Ltd. Dividend multiple calculate the price of a stock to the dividend
paid and it is used to measure the company’s potential as an investment ("Price-
dividendratiodefinitionandmeaning|CollinsEnglishDictionary",n.d.). Problem face by using
dividend multiple to estimate fair price of company is that we will not have a clear
benchmark to compare Xepa-Osmond’s dividend to the others companies’ dividend, due to
different dividend policy using by each company in different growth stage ("Dividend Payout
Ratio Definition & Example | InvestingAnswers", n.d.). Furthermore, dividend multiple only
focus on the dividend of the company but ignore the capital gains components, this will lead
to a less accurate and relatively low value of valuation. Besides, there are some profitable
companies do not pay dividend but rather retained it to invest into the more profitable
investment. So these companies will have a relatively low fair price but they might provide a
higher return in capital gains ("Dividend Yield | efinancemanagement.com", n.d.). Thus, by
using dividend multiple as the approach to estimate the fair price of Xepa-Osmond Pharmacy
Ltd seem to be suitable.

4) In your opinion, is corporate valuation exercise more of an art or a science?

Corporate valuation is a combination of both the Art and as a science, in terms of corporate
valuation as an art it involves some components such as forecasts, capitalization of the rates
in valuation and the outlook in terms of economy, in terms of the discounted rate and the
determination of economic outlook and discounted rate determination. The corporate
valuation in terms of science in includes the approaches of valuation (Wood and Sangster,
2012). The formulas that are used in the computation of the working capital in the valuation
of corporate finance the tests should be carried out since they are necessary in the analysis of
the investments of Xepa-Osmond pharmacy limited. In the way the firm will invest in the
value it does not only require the exercise of paint-by-numbers in the valuation, because the
business and its value it as many variables that it depends on the assessment of the value can
be only be achieved within a close range.
In the valuation of corporate exercise we need both aspects to make it a complete exercise,
its considered a science a most business valuation endeavor are mostly science and a bit of art
added to it to make a valuation complete. In the approaches of measuring value in the context
of valuation of a business we have the market, the income generated and the third one we
have the cost aspect (Ameer, 2003). The income concept approach is considerable in the
future cash flow and future earnings of the business capacity, and the cash flow are
discounted to the PV (present values).

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