Mergers and acquisitions

August 2025

1 Questions

Question 4b

KK Ltd. and JP Ltd. are companies operating in the same line of business. In the recent past, KK Ltd. has experienced very stiff competition from JP Ltd. such that KK Ltd., is considering acquiring JP Ltd. in order to consolidate its market share.

The following financial data is available about the two firms:

	KK Ltd.	JP Ltd.
Annual sales (Sh.“million”)	1,200	300
Net income (Sh.“million”)	450	60
Outstanding number of ordinary shares (million)	150	30
Earnings per share (Sh.)	3.0	2.0
Market price per share (Sh.)	60	30

Both companies are in the 30% income tax bracket

Required:

(i) Maximum exchange ratio that KK Ltd. should agree to if it expects no dilution in its post acquisition earnings per share (EPS).

(ii) KK Ltd.’s post acquisition EPS assuming the companies agree an offer price of Sh.45.

(iii) KK Ltd.’s post acquisition EPS assuming that for every 600 ordinary shares of JP Ltd.’s are exchanged for 10 units of 10% debentures of Sh.1,000 par value each.

(iv) The operating profit, Earnings Before Interest and Tax (EBIT) at point of indifference between earnings of the firm under the financing plans in (b) (ii) and (b) (iii) above.

(v) The EPS at the point of indifference between earnings of the firm under the financing plans in (b) (ii) and (b) (iii) above.

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April 2025

1 Questions

Question 3c

Huge Ltd. is considering acquisition of Tiny Ltd. through a share exchange arrangement. Under the terms of acquisition, Huge Ltd. will offer two of its ordinary shares in exchange for every three ordinary shares in Tiny Ltd.

The summarised financial information relating to the two companies for the year ended 31 December 2024 are as shown below:

	Huge Ltd.	Tiny Ltd.
Profit after tax (Sh.)	225 million	45 million
Number of ordinary shares	37.5 million	12 million
Earnings per share (Sh.)	7.20	4.50
Market price per share (Sh.)	93.60	40.50
Price earnings (P/E) ratio	13 times	9.00 times

Required:

(i) The earnings per share (EPS) of the combined company after acquisition.

(ii) Assume the price earnings ratio after acquisition falls to 12 times, determine the premium received by the shareholders of Tiny Ltd. (Use the combined company’s new share price).

(iii) Assume that the price earnings (P/E) ratio after acquisition falls to 12 times, justify whether acquisition would be beneficial to the shareholders of Huge Ltd.

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December 2024

1 Questions

Question 5a

Discuss FOUR potential pitfalls that a merger analyst should consider when reviewing acquisition transactions.

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August 2024

1 Questions

Question 3c

Jaribu Ltd. is considering acquiring Upendo Ltd. Selected financial data for the two companies is provided:

	Jaribu Ltd.	Upendo Ltd.
Annual sales (Sh.million)	1,500	180
Net income (Sh.million)	120	15
Ordinary shares outstanding (million)	30	6
Earnings per share (EPS) (Sh.)	8	5
Market price per share (Sh.)	88	40

Both companies are in the 30% tax bracket.

Required:

(i) The maximum exchange ratio that Jaribu Ltd. should agree to if it expects no dilution in earnings per share (EPS).

(ii) Post merger EPS of Jaribu Ltd. and Upendo Ltd. if the two companies settle on a price of Sh.48.40 per share.

(iii) Jaribu Ltd.’s EPS if Upendo Ltd.’s shareholders accept one (1) 12% convertible preference share with a par value of Sh.100 for every 5 ordinary shares they own.

(iv) Explain the term “bootstrapping earnings” as used in mergers and acquisition.

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April 2024

1 Questions

Question 3b

Duet Ltd. is considering a takeover bid for Small Ltd., another company in the same industry. Small Ltd. is expected to have earnings next year of Sh.129,000,000.

If Duet Ltd. acquires Small Ltd., the expected results from Small Ltd. will be as follows:

	Year after acquisition
Year	Year 1 Sh.“000”	Year 2 Sh.“000”	Year 3 Sh.“000”
Sales	300,000	420,000	480,000
Cash costs/expenses	180,000	240,000	270,000
Capital allowances	30,000	45,000	60,000
Interest charges	15,000	15,000	15,000
Cash flows to replace assets and finance growth	37,500	45,000	52,000

Additional information:

From year 4 onwards, it is expected that the annual cash flows from Small Ltd. will increase by 4% each year in perpetuity.
Tax is payable at the rate of 30%. Tax is paid in the same year it falls due.
If Duet Ltd. acquires Small Ltd., it estimates that gearing after the acquisition will be 35% (measured as the value of its debt capital as proportion of total equity plus debt).
The cost of debt is 7.4% before tax. Duet Ltd. has an equity beta of 1.60.
The risk free rate of return is 6% and the return on the market portfolio is 11%.

Required:

(i) The offer price for Small Ltd. assuming Duet Ltd. chooses to value Small Ltd. on a forward price earnings (P/E) multiple of 8 times.

(ii) The cost of capital of Duet Ltd.

(iii) Determine the offer price for Small Ltd. using discounted free cash flow (DCF) valuation method.

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December 2023

2 Questions

Question 3a

Highlight SIX economic and financial justifications advanced for mergers and acquisitions.

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Question 3b

Kubwa Ltd. is considering acquisition of Ndogo Ltd., a firm in an unrelated line of business in order to diversify their risks.

Selected financial data for both firms are provided as follows

	Kubwa Ltd.	Ndogo Ltd.
Sales (Sh.million	100	50
Cost of sales (Sh.million)	30	10
Operating costs (Sh.million	10	5
Finance cost (Sh.million)	5	2
Number of issued shares (million)	10	7
Market price per share (Sh.)	40	20

Additional information:

1. Kubwa Ltd. is considering financing the acquisition of Ndogo Ltd. using a share for share exchange or share debenture exchange.

2. Corporation tax rate applicable is 30%.

Required:

(i) Non-diluting maximum exchange ratio.

(ii) The post acquisition earning per share (EPS) assuming an offer price is set at Sh.30 per share.

(iii) The post acquisition EPS assuming 1,000 ordinary shares are exchanged for 10 units of 15% debenture with par value of Sh.100 each.

(iv) Considering your results in (b) (ii) above and (b) (iii) above, advise on the best financing plan.

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August 2023

3 Questions

Question 2a

Explain the following terms as used in mergers and acquisitions:

(i) Poison pill.

(ii) Staggered board of directors.

(iii) Golden parachutes.

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Question 5a

Assess THREE indicators of an organisation restructuring.

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Question 4b

The statement of financial position of two companies, Aco Ltd. and Bero Ltd. as at 31 December 2022 are shown below:

	Aco Ltd. Sh.“000”	Bero Ltd. Sh.“000”
Ordinary share capital (Sh.10 par value)	10,000	5,000
Preference share capital	2,000	-
Share premium account	-	200
Profit and loss account balance	3,800	400
10% debentures	1,500	500
	17,300	6,100
Non-current assets	12,200	3,500
Net current assets	5,100	2,600
	17,300	6,100

Additional information:

1.	Aco Ltd. is proposing to acquire Bero Ltd. by means of an issue of its own ordinary shares in exchange for the ordinary shares of Bero Ltd.
2.	The management of the two companies have availed the following information to assist in the takeover:

		Aco Ltd.	Bero Ltd.
	Maintainable annual profits after tax attributable to equity holders	Sh.2,400,000	Sh.1,500,000
	Current market price per ordinary share	Sh.24	Sh.27
	Current earnings per share (EPS)	Sh.2.4	Sh.3.0
3.	The corporation tax rate is 30%.

Required:

Using the following valuation basis and assuming no synergy effects accrue from the takeover, determine the total number of shares the directors of Aco Ltd. will have to offer to the shareholders of Bero Ltd:

(i) Net asset value basis.

(ii) Earnings per share basis.

(iii) Market value basis.

(iv) Present value of future earnings basis.

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April 2023

2 Questions

Question 2a

(i) Differentiate between “white knight” and “white squire” in relation to mergers and acquisitions.

(ii) Felix Bodo has collected the following information relating to the pro-forma financial statements of ABC Ltd., a company that is a target of its competitors.

Pro forma statement of profit or loss:

			Year
	2022 Sh.“000”	2023 Sh.“000”	2024 Sh.“000”	2025 Sh.“000”	2026 Sh.“000”
Revenue	15,752	17,327	19,060	20,966	23,023
Cost of goods sold	8,664	9,530	10,483	11,531	12,685
Gross profit	7,088	7,797	8,577	9,435	10,378
Selling, general expenses	2,363	2,599	2,859	3,145	3,459
Depreciation	551	606	667	734	807
Earning before interest and taxes	4174	4,592	5,051	5,556	6,112
Net interest expense	642	616	583	543	495
Earning before taxes	3,532	3,976	4,468	5,013	5,617
Income tax	1,236	1,392	1,564	1,755	1,966
Net income	2,296	2,584	2,904	3,258	3,651

Selected pro forma statement of financial position:

			Year
	2022 Sh.“000”	2023 Sh.“000”	2024 Sh.“000”	2025 Sh.“000”	2026 Sh.“000”
Change in deferred income tax	19	21	23	26	28

Selected pro forma cash flow statement:

			Year
	2022 Sh.“000”	2023 Sh.“000”	2024 Sh.“000”	2025 Sh.“000”	2026 Sh.“000”
Change in networking capital	455	551	607	667	734
Capital expenditures	1,461	1,709	1,880	2,068	2,275

Additional information:

1. ABC Ltd. has a corporate tax rate of 30%.

2. The weighted average cost of capital is 10%.

3. The terminal growth rate is 6%.

Required:

Determine using the discounted free cash flow analysis the value of ABC Ltd.

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Question 5b

Explain THREE divestment strategies available to a company undertaking restructuring.

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December 2022

2 Questions

Question 4a

Examine FOUR stages that a company might go through during restructuring.

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Question 5c

Alpha Ltd. and Beta Ltd. are companies operating in the same line of business. In the recent past, Alpha Ltd. has experienced very stiff competition from Beta Ltd. such that Alpha Ltd. is considering acquiring Beta Ltd. in order to consolidate its market share.

The following financial data is available about the two firms:

	Alpha Ltd.	Beta Ltd.
Annual sales (Sh.million)	400	100
Net income (Sh.million)	150	20
Outstanding number of ordinary shares (millions)	50	10
Earnings per share (Sh.)	3.0	2.0
Market price per share (Sh.)	30	15

Both companies are in the 30% income tax bracket.

Required:

(i). Maximum exchange ratio that Alpha Ltd. should agree to if it expects no dilution in its post acquisition Earning Per Share (EPS).

(ii). Alpha Ltd.’s post acquisition earning per share if the companies agree on an offer price of Sh.40.

(iii). Alpha Ltd.’s post acquisition earning per share if for every 200 ordinary shares of Beta Ltd.’s are exchanged for 5 units of 10% debenture of Sh.500 per value each.

(iv). Combined operating profit (EBIT) and post acquisition earning per share at point of indifference between earnings of the firm under the financing plans in (c) (ii) and (c) (iii) above.

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August 2022

2 Questions

Question 2b

Rona Hotel Ltd. is currently evaluating a proposal to take over Duet Restaurant Ltd. The Board of directors of Rona Ltd. is in the process of making a proposal for acquisition of Duet Restaurant Ltd. but first needs to place a value on the company.

Rona Ltd. has gathered the following financial data:

Rona Hotel Ltd.:

1.	Weighted average cost of capital	12%
2.	Price to earnings (P/E) ratio	12 times
3.	Shareholders required rate of return	15%

Duet Restaurant Ltd.:

1.	Current dividend payment per share (DPS) Sh.2.7
2.	Past five years dividend payment:
	Year	2017	2018	2019	2020	2021
	Dividend per share (DPS) (Sh.)	1.5	1.7	1.8	2.1	2.3
3.	The current Earnings Per Share (EPS) is Sh.3.7
4.	The number of issued ordinary shares are 5 million shares.

Additional information:

1. It is estimated that the shareholders of Duet Restaurant Ltd. require a rate of return of 10% higher than that of Rona Ltd. owing to the higher level of risk associated with Duet Restaurant Ltd.’s operations.

2. Rona Restaurant Ltd. estimates that the free cash flows from Duet Restaurant Ltd. at the end of the first year will be Sh.2.5 million and these will grow at an annual rate of 5% for the first 4 years after which the growth rate will revert to the historical earnings/dividend growth rate in perpetuity.

3. Rona Ltd. expects to raise Sh.5 million at the end of year 2 by selling off hotels of Duet Ltd. that are surplus of its needs.

Required:

Estimate values of Duet Restaurant Ltd. using the following valuation approaches:

(i) Price/earnings ratio model.

(ii) Dividend growth model.

(iii) Discounted free cash flow basis.

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Question 4b

In relation to corporate restructuring and reorganisation, discuss the potential advantages for a company undertaking the divestment of one of its division by means of:

(i) A sell off.

(ii) A demerger.

(iii) A divestment.

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April 2022

3 Questions

Question 4d

Viwanda Manufacturers Ltd.’s current earnings per share (EPS) is Sh.5.0. The company has an asset beta of 0.90 and adopts a 40% dividend payout ratio as its dividend policy. The risk-free rate of return is 5% and the equity market risk premium is 10%.

The management of Viwanda Manufactuers Ltd. intend to undertake a financial reconstruction which will result in a debt to equity ratio change from 0.15 to 0.30. Debt is considered to be risk free. Corporation tax applicable is 30%.

Required:

Show the impact of the financial reconstruction on the weighted average of cost capital (WACC) of the firm.

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Question 2c

Explain the following terms as used in corporate restructuring and reorganisation:

(i) Leveraged buyout (LBO).

(ii). Argenti’s A Score Model.

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Question 5a

Songo Ltd. has decided to acquire Twiga Ltd.

The financial data for the two companies are given as follows:

	Songo Ltd.	Twiga Ltd.
Net sales (Sh.“‘million”)	350	45
Profit after tax (Sh.“million’”)	28.13	3.75
Number of issued shares (“million”)	7.5	1.5
Earnings per share (EPS) (Sh.)	3.75	2.5
Dividend per share (DPS) (Sh.)	1.3	0.6
Total market capitalisation (Sh.“‘million”)	420	45

Required:

(i) Pre-acquisition market price per share (MPS) of the combined firm.

(ii) Post acquisition earnings per share (EPS) if Twiga Ltd.’s shareholders are offered a share of Sh.30 on a share-for-share exchange.

(iii) If the Price-Earnings ratio of Songo Ltd. drops to 12 times after the acquisition, determine the firm’s post acquisition market price per share.

(iv) Formulate a suitable criteria that should guide Songo Ltd. in determining whether to acquire Twiga Ltd. or not.

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Pilot December 2021

3 Questions

Question 1b

(i) Discuss the main economic and financial justification advanced for mergers and acquisitions.

(ii) According to evidence, to what extent do the shareholders of the companies tend to benefit from such an activity?

(iii) According to the evidence, to what extent do the managers of companies tend to benefit from such activity?

(iv) Explain what are referred to as “managerial” motives for mergers and acquisitions (M&A).

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Question 1a

GLD Building Group is contemplating a takeover of Diarim Enterprise Ltd., a manufacturer of earthmoving equipment.

The following information is available about the two companies.

	GLD	Diarim
Number of shares in issue	6,000,000	4,000,000
Dividend per share	Sh 0.30	Sh 0.90
Price per price	Sh.8.91	Sh.3.20

Additional information.

1. The cost of equity capital for both firms is 10%.

2. From a level of Sh.0.06 per share 6 years ago, GLD’s dividends has grown to the current level of Sh. 0.09 per share.

3. GLD’S management is confident that managerial synergies arising as a result of proposed takeover will enable them to increase Diarim Ltd’s past dividends growth rate by a further 1%.

4. The merger will involve transactions cost of Sh.500000.

Required:

Based on the approximate dividend growth rate, estimate the post-acquisition value of Diarims Ltd. using the dividend growth model, and evaluate the value gain arising as a result of the takeover.

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Question 4a

Unbundling is the process of selling off incidental non-core businesses to release funds, to reduce gearing in order to allow management to concentrate on their chosen core business.

In relation to corporate restructuring and reorganization, briefly explain the following forms of unbundling:

(i) Management buyout (MBO).

(ii) Management buy in (MBI).

(iii) Spin off or demerger.

(iv) Sell off or divestment.

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December 2021

5 Questions

Question 4a

Discuss four defense tactics available to target companies facing hostile takeover by predators.

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Question 2b

Kubwa Ltd. is considering acquiring Ndogo Ltd. The selected financial data for the two companies is as follows:

	Kubwa Ltd.	Ndogo Ltd.
Annual sales (Sh.million)	500	150
Net income (Sh.million)	40	5
Number of ordinary shares (millions)	10	2.5
Earnings per share (Sh.)	4.0	2.0
Market price per share (Sh.)	30	10

Both companies are in the 30% tax bracket.

Required:

(i) Kubwa Ltd.'s post acquisition earnings per share (EPS) assuming the two companies settle on an offer price of Sh.20 on a share for share exchange.

(ii) Kubwa Ltd.'s post acquisition earnings per share (EPS) assuming Ndogo Ltd.'s shareholders accept one 10% debenture (par value of Sh.1,000 each) for every 50 ordinary shares held.

(iii) The level of combined operating profit (EBIT) that Kubwa Ltd. will be indifferent between financing options in (b) (i) and (b) (ii) above.

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Question 3a

Different companies have varied aims and timings for undertaking corporate restructuring. However, the single common objective in every restructuring exercise is to minimise the disadvantages and maximise on the advantages.

Comment on the above statement highlighting five reasons for undertaking corporate restructuring.

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Question 3b

Distinguish between the following terms in relation to corporate restructuring and reorganisation:

(i) "Demerger" and "spin-off".

(ii) "Management buyout" and "management buy-in".

(iii) "Unbundling" and "capital re-organisation".

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Question 3c

The following data relates to Kaban Ltd., a company that operates in the manufacturing sector for the year ended 31 December 2020:

	Sh. "000"
Sales	25,678
Total assets	49,579
Total liabilities	5,044
Retained earnings	1,770
Net working capital	(1,777)
Earnings before interest and taxes	2,605
Market value of equity	10,098
Book value of total liabilities	5,044

The company is currently paying interest on a long term debt instrument amounting to Sh.905.000 per year and that the company's total liabilities is constituted in the ratio of 2:5 between current and non-current components.

Required:

Using the Springate model, assess the financial health of the company.

Note: The Springate model takes the following form:

Z = 1.03A + 3.07B + 0.66C + 0.4D

Where:

\(A =\)\(\displaystyle \frac{\text{Net Working Capital}}{\text{Total Assets}}\)

\(В =\) \(\displaystyle \frac{\text{Operating Profit}}{\text{Total Assets}}\)

\(C =\)\(\displaystyle \frac{\text{Net Profit Before Taxes}}{\text{Current Liabilities}}\)

\(D =\)\(\displaystyle \frac{\text{Sales}}{\text{Total Assets}}\)

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September 2021

4 Questions

Question 5c

Duncan Kipchumba, the director of Wote Ltd. met Lewis Khaminwa, the director of Toa Limited during a conference in Kisumu City. They had some discussion about their two companies. After flying back to Nairobi, Duncan Kipchumba proposed to his board of directors the acquisition of Toa Ltd.

During his presentation to the Board, he stated that "as a result of this takeover, we will diversify our operations and earnings per share will rise by 13% bringing great benefits to our shareholders".

No bid has yet been made and Wote Limited currently owns 2% of Toa Ltd. A bid would be based on an exchange of shares between the two companies which would be one Wote Ltd. share for every six Toa Ltd. shares.

Financial data for the two companies include the following:

	Wote Ltd. Sh.("million")	Toa Ltd. Sh.("million")
Turnover	56.0	42.0
Profit before tax	12.0	10.0
Profit attributable to ordinary shareholders	7.8	6.5
Dividends payable	3.2	3.4
	4.6	3.1
Issued ordinary share capital (Sh."million")	20	15
Market price per share (MPS) (Sh.)	3.20	0.45
Par value per share (Sh.)	0.50	0.10

Required:

(i) The pre-merger price to earnings (P/E) ratio for both companies.

(ii) Post merger earnings per share (EPS).

(iii) Explain whether you agree with Duncan Kipchumba when he says that the takeover would bring great benefits to ordinary shareholders. Support your answer with relevant calculations.

(iv) The post-acquisition price of a share of Wote Ltd. assuming the bid is successful.

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Question 2b

Mamba Ltd.'s existing debt to equity ratio is 0.5 and its asset beta is 0.40. The company decides to undergo a financial reconstruction during which it would repurchase its outstanding shares using borrowed debt. This will change its debt to equity ratio to 0.90.

Additional information:

The risk-free rate is 6%
The return of the market portfolio is 14%.
The firm adopts a 60% payout ratio and expects to generate earnings per share (EPS) of Sh.6.0 in the current financial year.
The firm generates a net income of Sh.12 million and equity capital is Sh.96 million.
Corporation tax rate applicable is 30%.

Required:

(i) The firm's levered equity beta before and after the financial reconstruction.

(ii) The firm's cost of equity before and after the financial reconstruction using the capital asset pricing model (CAРM).

(iii) Analyse the impact of the financial reconstruction on the firm's share price.

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Question 5a

The number of hostile takeovers relative to friendly or uncontested takeovers is small. However, drama surrounds them and they usually capture the interest of the press and the public.

In light of the above statement, examine four legal measures that could be applied to counter mergers and acquisitions.

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Question 5b

Propose four types of financial synergies that could arise as a result of a merger.

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May 2021

5 Questions

Question 3a

(i) Explain the meaning of the term "unbundling" as used in corporate restructuring and reorganisation.

(ii) Describe four forms of unbundling a firm.

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Question 4a

Evaluate five defensive tactics available to a firm threatened by a hostile takeover in the industry.

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Question 4b

Apco Limited is considering to acquire Alpha Limited. The following are the financial data for the two companies:

	Apco Limited	Alpha Limited
Net sales (Sh.)	350,000	45,000
Profit after tax (Sh.)	18,130	3,750
Number of outstanding ordinary shares	7,500	1,500
Earnings per share (EPS)	3.75	2.50
Dividend per share (DPS)	1.30	0.60
Total market capitalization (Sh.)	420,000	45,000

Required:

(i) Determine the pre-merger market value per share for both companies.

(ii) Determine the post merger EPS, market price per share (MPS) and price earnings (P/E) ratio.

(iii) Compare Apco Limited's EPS assuming Alpha Limited's shareholders are offered Sh.100,000, 5% convertible debenture for each share held in Alpha Limited.

Assume a corporate tax rate of 30%.

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Question 4c

Makazi Ltd.'s current earnings per share is Sh.6.0. The firm has in issue 50 million ordinary shares which have a par value of Sh.20 each. The firm's total revenue and capital reserves amounts to Sh.500 million.

The company has an asset beta of 0.9 and a retention ratio of 60%.

The management of Makazi Ltd. intends to undertake a financial reconstruction which will result in a debt-equity ratio change from 0.45 to 0.2.

Additional information:

1. The risk free rate of return is 8%.

2. Expected rate of return of a market portfolio is 18%.

3. Corporation tax rate is 30%.

4. The firm's return on equity before and after the financial reconstruction will remain unchanged.

Required:

Evaluate the impact of the financial reconstruction on the firm's share price.

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Question 5a

Discuss four circumstances in which a decision could be made to liquidate a failing company rather than attempt to carry out a reconstruction.

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November 2020

1 Questions

Question 5a

Explain six reasons why mergers and acquisition deals fail despite good planning,

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November 2019

2 Questions

Question 5b

A Ltd. and B Ltd. are companies operating in the same line of business. In the past few years, A Ltd. has experienced stiff competition from B Ltd. to an extent that A Ltd. is now contemplating acquiring B Ltd. in order to consolidate its market share.

The following financial data is available about the two companies:

	A Ltd.	B Ltd.
Annual sales (Sh. million)	400	60
Net income (Sh. million)	40	9
Ordinary shares outstanding (million)	10	3
Earnings per share (EPS)	Sh.4.0	Sh.3.0
Market price per share (MPS)	Sh.60	Sh.30

Both companies are in the 30% income tax bracket.

Required:

(i) The maximum exchange ratio that A Ltd. should agree to assuming that it does not expect dilution in its post acquisition earnings per share (EPS).

(ii) The total premium the shareholders of B Ltd. would agree to receive at the exchange ratio in (b) (i) above.

(iii) A Ltd.'s post acquisition earnings per share (EPS) assuming that the two companies agree on an offer price of Sh.30.

(iv) A Ltd.'s post acquisition earnings per share (EPS) assuming that for every 100 ordinary shares of B Ltd., the shareholders are offered two, 12% debentures of Sh.500 par value.

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Question 5a

Briefly describe the following types of mergers:

(i) Horizontal.

(ii) Vertical.

(iii) Congeneric.

(iv) Conglomerate.

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May 2019

2 Questions

Question 2b

ABC Ltd. is a company listed in the local securities exchange. The company is foreseeing a growth rate of 12% per annum in the next two years. The growth rate is likely to be 10% per annum for the third and fourth year, then it will stabilise at 8% per annum in perpetuity.

The latest dividend to be paid was Sh.1.50 per share.

The required rate of return is 16%.

Required:

The intrinsic value of the share.

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Question 5b

Excellent Ltd. is considering acquiring Best Ltd. a firm in the same industry in order to consolidate its market share. Best Ltd. has been less profitable, so it has paid an average of only 20% in taxes during the last several vears. In addition, it has used little debt having a debt ratio of 25%. If the acquisition would be implemented, Excellent Ltd. could operate Best Ltd. as a separate. wholly owned subsidiary. This will increase Excellent Ltd.'s gearing ratio to 40%.

The following is a forecasted financial data for Best Ltd. over the next five years:

Year	1 Sh. "million"	2 Sh. "million"	3 Sh. "million"	4 Sh. "million"	5 Sh. "million"
Net sales	50	60	75	70	65
Operating costs	5	10	15	15	12
Selling and administration costs	10	10	8	9	11
Acceptable investment project costs	0.5	0.70	1.60	1,20	0.20

Additional information:

1. The risk-free rate of return is 8% and debt is considered to be risk-free.

2. Expected return of the market portfolio is 13%.

3 The firm's levered equity beta after acquisition is estimated at 0.80.

4. After 5 years, the net cash flows of Best Ltd. shall increase at a constant rate of 6% per annum in perpetuity.

5. Corporation tax rate is 30%.

6. The firm's gross profit margin is 40%.

7 Best Ltd. incurs fixed financing cost of Sh.2 million per annum.

8. The firm's equity shares and bonds are currently trading at par.

Required:

Determine the maximum price payable to acquire Best Ltd. using the discounted free cash flow basis.

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November 2018

2 Questions

Question 3a

The following are summarised financial statements of Dzikunze Limited as at 31 December 2015 to 31 December 2017:

Income statement for the year ended 31 December:

	2015 Sh."000"	2016 Sh."000"	2017 Sh."000"
Turnover	90,000	100,000	120,000
Operating profit	15,000	20,000	25,000
Interest	(2,000)	(4,000)	(5,000)
Profit before tax	13,000	16,000	20,000
Taxation (30%)	(3,900)	(4,800)	(6,000)
Profit after tax	9,100	11,200	14,000
Proposed dividends	(2,100)	(2,500)	(3,000)
Retained profit	7,000	8,700	11,000

Statement of financial position as at 31 December 2017:

	Sh."000"
Non-current assets	60,000
Current assets	40,000
	100,000
Financed by:
Ordinary share capital (Sh.20 par value)	30,000
Reserves	20,000
10% long term debentures (Sh.100 par value)	30,000
Short-term debts	20,000
	100,000

1. Stock market analysts expect post-tax earnings and dividends to grow at the rate of 25% per annum for the next three years. Thereafter, the annual growth rate will revert to the company's growth rate an remain constant in each year to perpetuity.

2. Dzikunze Ltd.'s overall beta is 0.80 and the beta of equity is 0.75.

3. The risk-free rate of return is 12%.

4. The market rate of return is 28%.

5. The current market price of ordinary share is Sh.67.70 cum-dividend.

6. The debenture price is Sh.89.50 ex-interest.

7. The corporation tax rate is 30%.

Required:

(i) Evaluate whether Dzikunze Ltd.'s share is currently overvalued or undervalued by the market forces.

(ii) Advise a prospective investor whether to buy the ordinary shares of Dzikunze Limited.

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Question 4c

Chilulu Industries Limited is considering acquisition of Roka Corporation Ltd. in a share for share exchange. The financial data for the two companies are given below:

	Chilulu Ltd. (Sh.)	Roka Ltd. (Sh.)
Sales (millions)	500	100
Net earnings (millions)	30	12
Ordinary shares outstanding (millions)	6	2
Ordinary share market price, per share (MPS)	50	40
Dividend per share (DPS)	2	1.50

Additional information:

1. Chilulu Limited is not willing to incur an initial dilution in its earnings per share (EPS).

2. Chilulu Limited will have to offer a minimum of 25% of Roka Ltd.'s current share market price.

Required:

(i) The relevant offer price range.

(ii) If Roka Ltd.'s shareholders accept an offer by Chilulu Ltd. of Sh.40 per share in a share for share exchange. Determine the post-merger earnings per share (EPS).

(iii) Using the results obtained in (c) (ii) above and assuming that Chilulu Ltd.'s price-earning (P/E) ratio will remain unchanged after the merger, determine the post acquisition market price of a share of Chilulu Limited.

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May 2018

4 Questions

Question 5a

Assess five limitations of applying the free cash flow (FCF) approach using the weighted average cost of capital (WACC) as a discount rate when evaluating projects with different risks or debt capacity.

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Question 5d

Kisima Ltd. expects free cash flows of Sh.7.36 million this year and a future growth rate of 4% per annum. Currently, the firm has Sh.30 million in debt outstanding. This leverage will remain fixed during the year but at the end of each year, Kisima Ltd. is expected to increase or decrease its debt to maintain a constant debt/equity ratio.

Kisima Ltd. pays 5% interest on its debt and has an unlevered cost of capital of 12%.

The corporate tax rate is 40%.

Required:

Compute the value of Kisima Ltd.

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Question 3c

Nangina Ltd. is considering acquiring Bwiri Ltd. Nangina Ltd. is contemplating financing of the acquisition of Bwiri Ltd. using any of the following options:

Option 1: An ordinary share for ordinary share exchange

Under the terms of acquisition, Nangina Ltd. will offer one of its ordinary shares for every two shares in Bwiri Ltd.

Option 2: Ordinary shares for debentures exchange

Nangina Ltd. expects to offer 2 units of 10% debentures for every 100 ordinary shares in Bwiri Ltd. Each unit of debenture has a par value of Sh.100 each.

The summarised financial information relating to the two companies for the year ended 30 November 2017 was as follows:

	Nangina Ltd.	Bwiri Ltd.
Profit after tax (Sh.)	120 million	30 million
Number of shares	20 million	6 million
Earnings per Share (EPS) (Sh.)	6	5
Market price per share (Sh.)	50	25
Price earnings ratio	8.33 times	5 times

The corporate tax rate is 30%.

Required:

Determine the combined operating profit of the two firms and the post acquisition earnings per share (EPS) at the point of indifference in the firm's earnings under financing options (1) and (2) above.

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Question 3a

Describe the following pre-offer takeover defensive mechanisms:

(i) Poison pills.

(ii) Golden parachutes.

(iii) Fair price amendments.

(iv) Supermajority voting provisions.

(v) Restricted voting rights.

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November 2017

3 Questions

Question 2a

Discuss three reasons why economic value added (EVA) is gaining prominence as an alternative measure of a company's financial performance.

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Question 3a

Discuss three reasons why acquisitions often fail to enhance shareholder value.

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Question 3b

Mkuki Ltd. is considering making a bid for 100% of the shares of Ngao Ltd., a company in a completely different industry. The bid of Sh.200 million, which is expected to be accepted, will be financed entirely by new debt with a post-tax cost of debt of 7%.

1	Pre-acquisition information: Mkuki Ltd. The company has debt finance totalling Sh.60 million at a pre-tax rate of 10%. The company has 50 million equity shares each with a current market value of Sh.22. The equity beta is 1.37. The post-tax operating cash flows of Mkuki Ltd. are as follows:

	Year	1	2	3	4	5
	Sh"million"	60.3	63.9	67.8	71.8	76.1

Ngao Ltd.
The company has an equity beta of 2.5 and 65 million equity shares in issue with a total current market value of Sh.156 million.
The company's debt, which will also be taken over by Mkuki Ltd., stands at Sh.12.5 million at a post-tax rate of 7%.

2	Post-acquisition information: Land with a value of Sh.14 million will be sold. The post-tax operating cash flows of Ngao Ltd's current business will be:

	Year	1	2	3	4	5
	Sh"million"	15.2	15.8	16.4	17.1	17.8

3	If the acquisition goes ahead, Mkuki Ltd. will experience an improvement in its credit rating and all existing debts will be charged at a post-tax rate of 7%.
4	Cash flows after year 5 will grow at the rate of 1.5% per annum.
5	The risk-free rate is 5.2% and the market risk premium is 3%.
6	The corporate tax rate is 30%.

Required:

Advise whether the acquisition should proceed.

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May 2017

3 Questions

Question 5a

A Ltd. is considering acquiring B Ltd. The selected financial data for the two companies are as follows:

	A Ltd.	B Ltd.
Annual sales (Sh."million")	600	120
Net income (Sh."million")	35	3
Ordinary shares outstanding ("millions")	10	2
Earnings per share (EPS) - Sh.	3.5	1.5
Market price per share (MPS) - Sh.	40	15

Both companies are in the 30% tax bracket.

Required:

(i) The maximum exchange ratio that A Ltd. should agree to if it expects no dilution in earnings per share.

(ii) Total premium that the shareholders of B Ltd. would receive at the exchange ratio caiculated in (a) (i) above.

iii) A Ltd.'s post acquisition earnings per share, if the two companies settle on a price of Sh.20 per share.

(iv) A Ltd.'s post-acquisition earnings per share if every 50 ordinary shares of B Ltd. were exchanged for one 8% debenture of a par value of Sh.1,000 each.

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Question 3b

The following data relate to two companies namely; V Ltd. and J Ltd. operating in the same line of business.

Financial data as at 30 April 2017:

	V Ltd.	J Ltd.
Market value of debt (Sh."billion")	6.60	11.60
Market value of equity (Sh."billion")	19.80	13.40
Number of shares in issue ("million")	680.00	880.00
Share options outstanding ("million")	50.80	-
Exercise price per option (Sh. per share)	22.00
Corporate tax rate	30%	30%
Equity beta	1.85	1.95
Default risk premium	1.6%	3.0%
Net operating profit after tax and net re-investment (Sh."million")	900	410
Current earnings per share (Sh. per share)	1.19	0.44

Additional information:

1. The global equity risk premium is 4% and the most appropriate risk-free rate derived from government securities is 3%.

2. The share options held by the employees were exercisable subject to the employees working for the company for the next three years.

3. The company has an annual employee attrition rate of 5% as employees leave and out of those remaining, 20% are expected not to have achieved the standard of performance required to exercise the options.

4. The options have a time value of Sh.7.31. 5. J Ltd. operates a defined benefit pension scheme which, at its current actuarial valuation, shows a deficit of Sh.860 million.

6. V. Ltd. which has managed to sustain a 5% growth rate in earnings per annum, is considering a debt-financed acquisition of J Ltd. In addition, V Ltd. believes that J Ltd. could register a growth rate of 4% per annum under its current management.

Required:

(i) The weighted average cost of capital (WACC) of both J Ltd. and V Ltd.

(ii) The current value of both J Ltd. and V Ltd.

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Question 3a

Examine four strategies that a company couid adopt to defend itself against a hostile takeover.

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November 2016

1 Questions

Question 4b

Kubwa Ltd., a supermarket chain, is proposing to take-over Small Ltd., a smaller firm in the same industry. In its bid. Kubwa Ltd. has offered four of its shares for every three shares of Small Ltd.

The following are the latest summarised accounts of the two companies:

Statements of financial position
Non-current assets:	Sh."million"	Kubwa Ltd. Sh."million"	Sh."million"	Small Ltd. Sh."million"
Land		966		84.6
Other non-current assets		300		34
		1,266		118.6
Current assets:
Inventory	656		102.8
Accounts receivable	24		12.6
Cash	88		10.6
	768		126.0
Current liabilities:
Trade payables	894		92.2
Other accruals	68		8
Net current assets		(194)		25.8
Long-term liabilities:
14% loan stock	400		-	-
Floating rate loans	228		35
		(628)		(35)
Total net assets		444		109.4
Shareholders' funds:
Ordinary share capital		150		40
Reserves		294		69.4
Total shareholders' funds		444		109.4

Income statement
	Kubwa Ltd. Sh."million"	Small Ltd. Sh."million"
Turnover	2,260	362
Earnings before interest and tax	230	28
Interest	(80)	(4)
Profit before tax	150	24
Taxation	(50)	(8)
Earnings available to shareholders	100	16
Dividends	(48)	(10)
Retained earnings	52	6

Additional information:

1	The par value of the shares of Kubwa Ltd. is Sh.0.50 while the par value of Small Ltd's shares is Sh.1.00.
2	The current share price of Kubwa Ltd. is Sh.4.64 while that of Small Ltd. is Sh.5.90. The current loan stock price of Small Ltd. is Sh. 125.
3	Recent annual growth trends are as follows: Kubwa Ltd. Small Ltd. Dividends 7% 8% Earnings per share 7% 10%
4	The following will take place after the acquisition: Surplus warehousing facilities will be sold for Sh.13.6 million. Sh. 18 million will be paid out for redundancy of employees. There will be savings of Sh.5.4 million from wages every year for at least five years.
5	Kubwa Ltd. has an estimated cost of equity of 14.5% and a weighted average cost of capital of 12%.
6	Small Ltd. has an estimated cost of equity of 13%.

Required:

(i) Evaluate whether the bid is likely to be viewed favourably by the shareholders of both Kubwa Ltd. and Small Ltd.

(ii) Discuss three factors that are likely to influence the views of the shareholders in the analysis in (b) (i) above.

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May 2016

2 Questions

Question 4b

Huge Ltd. intends to take over Tiny Ltd., another company in the same industry. Tiny Ltd. is expected to post earnings of Sh.86 million next year.

If Huge Ltd. acquires Tiny Ltd., the expected results of Tiny Ltd., for the next three years will be as follows:

	Year after acquisition
	Year 1 Sh. "000"	Year 2 Sh. "000"	Year 3 Sh. "000"
Sales	200,000	280,000	320,000
Cash costs/expenses	120,000	160,000	180,000
Capital allowance	20,000	30,000	40,000
Interest charges	10,000	10,000	10,000
Cash to replace assets and finance growth	25,000	30,000	35,000

From year 4 onwards, it is expected that the annual cash flows from Tiny Ltd. will increase by 4% each year into perpetuity.

Tax is payable at the rate of 30% and this tax is paid in the same year the profits to which it relates are earned.

If Huge Ltd. acquires Tiny Ltd., it estimates that the gearing after the acquisition will be 35% measured as the value of debt as a proportion of the total equity and debt. After the acquisition of Tiny Ltd., Huge Ltd. would have a cost of debt of 7.4% before tax and a beta of 1.60.

The risk-free rate is 6% and the return on the market portfolio is 11%.

Required:

(i) The offer price for Tiny Ltd., if Huge Ltd. were to value Tiny Ltd. on a forward price earnings (P/E) multiple of 8.0 times.

(ii) The weighted average cost of capital (WACC) for Huge Ltd. after the acquisition of Tiny Ltd.

(iii) The offer price for Tiny Ltd. using a discounted cash flow (DCF) based valuation.

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Question 4a

With reference to corporate valuation, describe the importance of enterprise value (EV).

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November 2015

2 Questions

Question 4a

(i). Define the term "free cash flow to equity".

(ii). Explain how free cash flow to equity could be used for valuation.

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Question 1c

Evaluate four advantages of employing organic growth strategies.

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Pilot September 2015

1 Questions

Question 5a

In relation to corporate restructuring and re-organisation, distinguish between the term "demerger" and "spin off".

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Mergers and acquisitions

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