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 (10 Marks)

(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. (15 Marks)