QUESTION TWO.

(a) Briefly discuss three challenges that you would encounter when valuing a private company using discounted cash flow approach

(b) Nakuru Construction Limited is a private company with operation in six counties in Kenya. The company manufactures and sells various products. You have been tasked with the assignment of valuing the private firm using discounted cash flow approach. You have been provided with the following information for the company and that of five similar firms in the industry.

(i) Data for Nakuru Construction Limited for the most recent period

Revenues	Sh. 30 Million
Earnings Before Interest and Tax	Sh. 9 Million
Capital Expenditure	Sh. 4 Million
Working Capital Investment	Sh. 2 Million
Depreciation	Sh. 2 Million

(ii) Corporate tax rate relevant for Nakuru Construction Limited is 30 % and its before tax cost of debt is 10 %

(iii) Extracts from the statement of financial position of Nakuru Construction Limited for the most recent period is as shown below.

Ordinary Share Capital (Sh. 1.5 Par value)	Sh. 300 Million
Borrowings	Sh. 75 Million

Based on data from the similar firms, it was established that on average market value of equity is two times that of the book value. However, the book value of debt was found to be equal to its equivalent market value.

(iv) The estimated beta for each comparable firm in the same industry as Nakuru Construction Limited is as shown. The five firms are listed at the local securities market

S/N	Comparable Firm	Beta ()
1	A	1.4
2	B	1.8
3	C	1.2
4	D	1.35
5	E	1.5

(v) The market values for debt and equity for each of the five comparable firms is presented below

S/N	Comparable Firm	Market Value of Debt	Market Value of Equity
1	A	20	70
2	B	25	100
3	C	15	65
4	D	30	120
5	E	20	90

(vi) Average return on market and risk free rate of return has been estimated at 12 % and 7 % respectively.

(vii) Nakuru Construction Limited expects Revenues, Earnings before interest and taxes, fixed capital investment, investment in working capital and depreciation to grow at an annual rate of 5 % each year for 10 years. After the ten year growth period, the growth in revenues, earnings before interest and taxes, investment in working capital will decline to stable 3 percent each year, and fixed capital investment and depreciation will offset each other.

Required:

(a) Compute Free cash flow for the most recent period

(b) Compute after tax cost of debt for Nakuru Construction Limited

(c) Compute cost of equity Nakuru Construction Limited

(d) Compute weighted average cost of Capital Nakuru Construction Limited

(e) Compute Terminal value for Nakuru Construction Limited

(f) Compute the fundamental value of Nakuru Construction Limited