QUESTION THREE The Kenyan economy recorded a positive growth in the last quarter
ID: 2801171 • Letter: Q
Question
QUESTION THREE The Kenyan economy recorded 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 Kenya and has chosen acquisition as a way of expanding. The company has identified Umoja Ltd. as a target company. As a student of corporate valuation, you have been tasked with 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 thousand of Kenya shillings. Year Free cash flow to firm Outstanding debt Annual capital expenditure 2015 2016 2017 2018 2019 2020 (current) 7,000 7,450 8,150 8,550 9,500 52,500 50,000 47,500 45,000 42,500 40,000 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.returh on the NSE-20 share index is 12 percent, and the long term Treasury bond rate is 6 percent. Umoja's Ltd's debt pays 8% (effective) interest, and its 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 percent and it intends to assume the current long-term debt equity rate of the target company Page 2 of 3Explanation / Answer
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
23664.48.4
particulars free cash flow present value@20% amount 2016 7000 0.833333333 5833.333333 2017 7450 0.694444444 5173.611111 2018 8150 0.578703704 4716.435185 2019 8550 0.482253086 4123.263889 2020 9500 0.401877572 3817.836934