Question

QUESTION:

The Kenyan economy registered a positive growth in the last quarter of 2015 and this is expected to continue, increasing companies' appetite for expansion.Buru enterprises is a company operating in Kenyaand has chosen acquisition as a way of expanding.The company has identified Umoja limited as as a target company.

As a student of corporate valuation, you have been tasked with the responsibility of advising Buru enterprises on whether they should proceed with the acquisition agenda.You have projected the financial statements of Umoja Limited and estimated its cash flows.Amounts are in thousands of Kenya Shillings.

                                                                          2015          2016     2017   2018    2019                    2020

Free Cash Flow from Firm                                   (current)     7,000    7,450    8,150          8.550                    9,500

Outstanding Debt                                                52,500    50 ,000    47,500    45,000     42,500                     40,000

Annual CApital Expenditure    11,800      12,000    12,500    12,500     12,700                     12,700

Annual Working Capital Investment     11,500 11,000     11,500    11,000    11,500    12,300

The current expected return on the NSE-20 share index is 12% , and a long term Treasury Bond Rate is 6%. Umoja ltd's debt pays 8% ( effective) interest , and it's stock levered beta is 1.5.Assume corporate tax rate of 30% for both companies.

Umoja ltd's debt principal is repaid in equal installments at the end of each financial period.

Buru enterprise intention is to raise finances such that it achieves its target long term debt- to -equity ratio for the target company of 40% and it intends to assume the current long -term debt equity rate of the target company.

Required:

(a) Compute the appropriate discounting rate of Umoja Ltd based on free cash flow using the adjusted present value approach

(b) Determine Umoja Ltd's value based on free cash flow to the firm using adjusted present value approach .In your computation , clearly state the implicit or explicit assumptions.

Assume that debt interest applies to the previous year's long term debt and that the residual cash flows to the firm are expected to increase at an annual rate of 2 % per year forever after 2020.

Answer 1

ANSWER:

unlevered beta = beta / 1 + (1 - tax rate) x (debt / equity).

=1.5/1+(1-0.4)*(0.4)

=1.5/1+0.24

=1.5/1.24

=1.209

Levered bottom-up beta = Unlevered beta (1+ (1-t) (Debt/Equity))

=1.209(1+(1-0.4)0.4

=1.209(1.24)

=1.49916

expected return = risk free return +beta(market return -risk free return)

=6+1.499(12-6)

=6+

=8.99

ADJUSTING FRESS CASH FLOWS TO THE PRESENT VALUE

Particulars	free cash flow	present value @20%	amount
2016	7000	0.833333333	5833.333333
2017	7450	0.694444444	5173.611111
2018	8150	0.578303704	4716.435185
2019	8550	0.482253086	4123.263889
2020	9500	0.401877572	3817.836934

23664.466