VALUATION

The management of XYZ Ltd is concerned about the fluctuating sales and earnings. The variability of the companys earnings has caused its P/E ratio at about 22 to be much lower than the industry average of about 45. The tables F1 below contain XYZ most recent extracted items from its financial statements. Currently, XYZ share is selling for Kshs.57.80 in the market.

Table: F1 XYZ extracted items

Financials	Kshs. Million
Outstanding debt	2710
Equity [(1575 million Outstanding shares)+ (2755 million Reserves and surplus)	4330
Note: Kshs.1575 million outstanding shares = Kshs 10*157.50 million shares

To boost its sales and bring stability to its earnings, XYZ management has identified ABC Ltd. as a possible target for acquisition. ABC is known for its quality of products and its nation wide markets. The company has not been performing well in the recent past due to poor management. Its sales have grown at 4% during the years against the industry growth rate of 8% annually. The current price of ABC share is Kshs.24.90. The management of XYZ is confident that after acquisition, they could turn around ABC. Table F2 and F3 below shows ABCs estimated Net Cash flows (Note that year 10 cash flows are inclusive of the terminal value) and ABCs extracted items. Its weighted average cost of capital is 13%.

Table: F2: Estimated Cash flows of ABC

year	1	2	3	4	5	6	7	8	9	10
Cashflows Kshs. (Millions)	49	72	107	128	139	150	162	175	189	2574

Table: F3: ABC extracted items

Financials	Kshs. Million
Outstanding debt	295
Equity [(250 million Outstanding shares)+ (425 million Reserves)]	675
Note:Kshs. 250 million outstanding shares = Kshs 10*25 million shares

Required;

i What is the value of ABC if XYZ acquired it? At what price should XYZ pay for each share of ABC?

ii How should XYZ finance the acquisition of ABC? Should it exchange shares or pay in cash?