a)Kenfront Ltd. is a firm that manufacturers personal computers. As a top manage

Question

a)Kenfront Ltd. is a firm that manufacturers personal computers. As a top manager in the firm, you are considering changes in the way the firm is run. Currently, the firm has after-tax opertaing income of Sh.50 Million on capital invested of Shs. 250Million(at the beggining of the year). The firm also reinvests Sh. 25 Million in net capital expenditures and working capital.

Required

Estimate the expected growth rate in earnings, given the firms current return on capital and re-investment rate

b) List and discuss five factors which should be considered when valuing a corporation

c) Discuss two approaches for calculating the terminal value in a multistage valuation

Explanation / Answer

A) Growth rate in earnings = Reinvestment rate * Return on capital

= (25/50)*(50/250)

= 0.1

= 10%

B) The five factors that should be considered while valuing a company:

A) Free cash flows: Ultimately, free cash flows are the main aim of the company. This is what goes in the pockets of shareholders or the ultimate earnings.

B) Growth rate: Growth rate is the one that determines how the business is going and will ultimately grow. This will determine the future of the business.

C) Cost of capital: Cost of capital determines whether it is actually good to stay in the business or not, whether the cash flows are giving benefits more than the cost of capital of not.

D) Type of business: Type of business determine the quality of cash flows and whether these are sustainable or not when the business line is considered.

E) Economic condition: Overall economic conditions determine whether the valuation of a company should be done at a discount rate or premium based upon the market conditions.

C) Two methods for calculating terminal value are:

Perpetuity Growth model : In this method, the cash flows are assumed to be increasing at a constant growth rate and are discounted by the difference of cost of capital and growth rate.

TV = Cash flow/(cost of capital - growth rate)

Terminal multiple method: In this based upon a multiple, for eg. EV/EBITDA, and the historical terminal value, the terminal value is projected.

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