QUESTION ONE The world economy recorded positive economic data in the recent time and it is expected that Kenyan economy will soon experience a period of growth and prosperity The adverse movement in exchange rates, inflation and interest rates occupied with the financial crisis made financially healthy firms stronger and weak firms weaker In order to profit from the expected growth, the strong companies are thinking of expanding their capacity Most of these companies have identified two sources of expanding their capacity, establishing new plants or by acquisitions Tazama Mabelle Ltd is a leading company in the sector and is aggressively looking for a target company Tazama Mabelle Ltd has identified a target RAT Ltd which is also being pursued by CAT Ltd CAT Ltd has made a bid valuing RAT at Sh 100, 000 After undertaking corporate valuation course, the Senior Management of Tazama Mabelle Ltd have come to you for an advice on whether they should proceed with the acquisition agenda You have projected RATs free flows and estimated other information if it is acquired as follows YEAR 0 1 2 3 4 5 Free cash flow to firm 6500 6950 7650 8050 9000 Outstanding L T debt 52500 50000 47500 45000 42500 40000 Annual capital amortization 11300 11500 12000 12000 12200 12200 New working capital 11000 10500 11000 10600 11000 11800 The current expected market return is 12 , and the long term Treasury bond rate is 6 RATs debt 8 (effective) interest Debt principal is repaid in equal amounts at the end of each financial period Its stock levered beta is 1 5 Assume that the corporate income tax rate for both Tazama Mabelle and RAT Ltd is 40 Tazama Mabelle intention is to raise finance such that it achieves its target long term debt to equity ratio for the target company of 40 and intends in its plans to assume the current long term debt of the target company Required By computations, identify the appropriate discount rates for the valuation of RAT Ltd based on the free cash flows to the firm (FCFF) using the adjusted present value (APV) method ( 5 marks) Identify the type of Merger and acquisition in this case Identify any four possible reasons for Tazama Mabelle Ltd to acquire RAT Ltd (5 marks) Determine RATs value including and excluding the long term debt based on the FCFF using the APV method (including debt and common shares only) Assume that the debt interest applies to the previous years long term debt, and that the residual cash flows to the firm are expected to increase at a rate of 3 per year (ignore taxation) (15 marks)

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QUESTION ONE The world economy recorded positive economic data in the recent time and it is expected that Kenyan economy will soon experience a period

QUESTION ONE

The world economy recorded positive economic data in the recent time and it is expected that Kenyan economy will soon experience a period of growth and prosperity. The adverse movement in exchange rates, inflation and interest rates occupied with the financial crisis made financially healthy firms stronger and weak firms weaker. In order to profit from the expected growth, the strong companies are thinking of expanding their capacity.

Most of these companies have identified two sources of expanding their capacity, establishing new plants or by acquisitions. Tazama Mabelle Ltd is a leading company in the sector and is aggressively looking for a target company.

Tazama Mabelle Ltd has identified a target RAT Ltd which is also being pursued by CAT Ltd CAT Ltd has made a bid valuing RAT at Sh.100, 000

After undertaking corporate valuation course, the Senior Management of Tazama Mabelle Ltd have come to you for an advice on whether they should proceed with the acquisition agenda.

You have projected RATs free flows and estimated other information if it is acquired as follows

YEAR
	0	1	2	3	4	5
Free cash flow to firm	--	6500	6950	7650	8050	9000
Outstanding L.T debt	52500	50000	47500	45000	42500	40000
Annual capital amortization	11300	11500	12000	12000	12200	12200
New working capital	11000	10500	11000	10600	11000	11800

The current expected market return is 12%, and the long term Treasury bond rate is 6%. RATs debt 8% (effective) interest. Debt principal is repaid in equal amounts at the end of each financial period. Its stock levered beta is 1.5. Assume that the corporate income tax rate for both Tazama Mabelle and RAT Ltd is 40%.

Tazama Mabelle intention is to raise finance such that it achieves its target long-term debt to equity ratio for the target company of 40% and intends in its plans to assume the current long term debt of the target company.

Required:

By computations, identify the appropriate discount rates for the valuation of RAT Ltd based on the free cash flows to the firm (FCFF) using the adjusted present value (APV) method ( 5 marks)
Identify the type of Merger and acquisition in this case. Identify any four possible reasons for Tazama Mabelle Ltd to acquire RAT Ltd. (5 marks)
Determine RATs value including and excluding the long-term debt based on the FCFF using the APV method (including debt and common shares only)

Assume that the debt interest applies to the previous-years long term debt, and that the residual cash flows to the firm are expected to increase at a rate of 3% per year (ignore taxation) (15 marks)