SUGGESTED SOLUTION

C3 – BUSINESS AND CORPORATE FINANCE

AUGUST 2023

ANSWER 1

(a) How change in the value of one currency affect the price of stock in the other
economy.

This is based on the purchasing power parity in the absence of any other risks,
prices of stocks in two economies should be equal, for given level of risks and
returns, once the exchange rate is considered.
➢ When the value of one currency increases it tends to make domestic stocks
expensive and foreign stocks cheaper (in relative terms).
➢ The demand of foreign stocks will increase and hence increase in their prices.

How change in the price of stocks in one economy affect the value of the other
economy currency.

This is based on the (uncovered) interest rate parity.

In the absence of any other risks, the returns of investments in two economies
should be equal once the factor in the exchange rate.
➢ When the stocks in one economy increases the returns of those stocks
increases such stocks become more attractive to foreign investors. The
increase in demand causes the demand of the currency of that economy
appreciates.
The two-exchange rate movements and stock price movements are not based
on the same theoretical underpinning.

(b) A-Tel Ltd and Z-Tel Ltd

(i) Use the perpetual growth model of stock valuation to find the appropriate
discount rate (r) for the common stock of Z-Tel Ltd.
80
= 2,000 r = 0.10 = 10%
𝑟−0.06

Under new management, the value of the combination would be the value
of A-
Tel Ltd before the merger (because A-Tel’s value is unchanged by the
merger) plus the value of Z-Tel Ltd after the merger, or:

Then calculate the gain from the acquisition

Gain = 𝑃𝑉𝐴𝑍 − (𝑃𝑉𝐴 + 𝑃𝑉𝑍 )
80
𝑃𝑉𝐴𝑍 = (1,000,000 x 9,000) + 600,000 x (0.1−0.08)
= 𝑇𝑍𝑆. 11,400,000,000

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 Gain = 11,400,000,000 – (9,000,000,000 + 1,200,000,000)
= TZS.1,200,000,000
ii. If cash acquisition

Cost = cash paid – 𝑃𝑉𝑍 = (TZS.2,500 x 600,000) – TZS.1,200,000,000

= TZS.300,000,000
iii. Based on shares
Because this acquisition is financed with shares, we have to take into
consideration the effect the merger on the stock price of A-Tel Ltd. After
the merger, there will be 1,200,000 shares outstanding. Hence, the share
price will be:
TZS.11,400,000,000/1,200,000 = TZS.9,500
Therefore:
Cost = (TZS.9,500 x 200,000) – (TZS.2,000 x 600,000)
= TZS.700,000,000
iv. Cost of the cash offer and the share offer
If the acquisition is for cash, the cost is the same as in part (ii), above:
Cost = TZS.300,000,000
If the acquisition is for shares, the cost is different from that calculated in
part (iii). This is because the new growth rate affects the value of the
merged company. This, in turn, affect the stock price of the merged
company and, hence, the cost of the merger.
It follows that:
𝑃𝑉𝐴𝑍 = (TZS.9,000 x 1,000,000) + (TZS.2,000 x 600,000)
= TZS.10,200,000,000

The new share price will be:

= TZS.10,200,000,000/1,200,000 = TZS.8,500.00
Therefore:
Cost = (TZS.8,500 x 200,000) – (TZS.2,000 x 600,000)
= TZS.500,000,000

(c) Factors for lower beta in international diversification

An internationally diversified portfolio tends to have a lower beta due to the
principle of diversification. Beta is a measure of a portfolio's sensitivity to overall
market movements. A beta of 1 indicates that the portfolio moves in tandem with
the market, while a beta greater than I suggests the portfolio is more volatile than
the market. Conversely, a beta less than 1 indicates the portfolio is less volatile than
the market.
When a portfolio is diversified across different countries and regions, it is exposed
to a broader range of economic factors, political events, and market conditions. As
a result, the individual country-specific risks tend to offset each other to some
extent, leading to a reduction in the overall portfolio’s volatility. This phenomenon
is known as “diversification benefits.”

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 By holding a mix of international investments, such as stocks and bonds from
different countries, an internationally diversified portfolio can reduce its exposure
to specific country risk and idiosyncratic events that affect individual markets.
Consequently, the portfolio's beta is lowered, indicating that its price movements
are not as closely tied to fluctuations in any particular market.

Different economic cycles. Different countries have different economic cycles,

which means that their stock markets are not perfectly correlated. When one
country's economy is doing well, its stock market may rise, while another country's
economy may be doing poorly, and its stock market may fall. This diversification
of economic cycles can help to reduce the overall risk of an internationally
diversified portfolio.

In summary, an internationally diversified portfolio is typically associated with a

lower beta due to the reduction in specific country risks and the beneficial effect of
diversification, which helps to smooth out overall portfolio volatility. Investors
often seek to create internationally diversified portfolios to manage risk and
potentially achieve better risk adjusted returns.

ANSWER 2

(a) Calculating beta Coefficients

[𝛽𝐵𝑆𝐸 ] = COV (LSE, FSE)/VAR(LSE)

COV (ASE, BSE)

State Pi RASE – E(RASE) RBSE – E(RBSE) RASE – E(RASE) RBSE –
E(RBSE)Pi
Winter 0.3 -2 2 -1.2
Summer 0.3 -2 2 -1.2
Autum 0.2 -2 -3 1.2
Spring 0.2 8 -3 -4.8
COV (ASE, BSE) = -
6

E(RASE) = 10% (3) + 10% (0.2) + 20% (0.2) = 12%

E(RASE) = 20% (0.3) + 20% (0.3) + 15% (0.2) + 15% (0.2) = 18%

VAR(ASE)
State Pi RASE – E(RASE) RBSE – (RASE –
E(RBSE)2 E(RASE)2Pi
Winter 0.3 -2 4 1.2
Summer 0.3 -2 4 1.2
Autum 0.2 -2 4 0.8
Spring 0.2 8 64 12.8
VAR(ASE) =16

𝐵 𝑆𝐸 = - 6/16
= - 0.375

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Comment: As the beta coefficient for the Frankfurt stock Exchange is less than 1.0. then
BSE is less risky than ASE.

C. Beta [𝛽𝐶𝑆𝐸]

[𝛽𝐶𝑆𝐸] = COV (ASE, CSE)/VAR(ASE)

COV (ASE, CSE)

State Pi RASE – E(RASE) RCSE – E(RCSE) RASE – E(RASE) RCSE –
E(RCSE)Pi
Winter 0.3 -2 -4 2.4
Summer 0.3 -2 -4 2.4
Autum 0.2 -2 6 2.4
Spring 0.2 8 6 9.6
COV (ASE, = 12
CSE)
E(RLSE) = 12%
E(RFSE) = 10% (0.3) + 10% (0.3) + 20% (0.2) + 20% (0.2) = 14%

VAR(ASE) = 16

βFSE = 12/16
= - 0. 75

Comment: As the beta coefficient for the c stock Exchange is less than 1.0 then CSE is
less risky than ASE.

Additions:
Given: Var(A) = ∑ Pi (Ri - RA)2
Then: Var (BSE)= 0.3 x 4 + 0.3 x 4 + 0.2 x 9 + 0.2 x 9 = 6
Var (CSE)= 0.3 x 16 + 0.3 x 16 + 0.2 x 36 + 0.2 x 36 = 24
Var (ASE)= 0.3 x 4 + 0.3 x 4 + 0.2 x 4 + 0.2 x 64= 16

Risk (Standard Deviation) = [ (0.5)2(16) + (0.5) (24)2 + 2(0.5) (0.5)(12)]1/2

= 4%
Using E(R) and Ꝺ
Alternative 1 : Invest 50% (ASE) and 50% (CSE)
E(RP)= 0.5x 12% + 0.5 x 14% = 13%
Ꝺp= ( 0.52 x 16 + 0.52 x 24 + 2 x 0.5x 0.5 x 12)1/2 =4

Alternative 2 : Invest 50% (ASE) and 50% (BSE)

E(RP)= 0.5x 12% + 0.5 x 18% = 15%
Ꝺp= ( 0.52 x 16 + 0.52 x 6 - 2 x 0.5x 0.5 x 6)1/2 =1.58

Using correlation Coefficient

Given: ꝭAB= CovAB
ꝹA.ꝹB

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Therefore:
ꝭASE,CSE = 12 = 0.612
4 x4.9

ꝭASE ,BSE = -6 = -0.612

4 x2.46
Therefore
BSE is the most suitable as it has negative correlation also offers higher return at a
relatively low risk.

THE NATURE OF AGENCY PROBLEM IN A MULTINATIONAL COMPANY

(b) In a multinational corporation agency relationships exist between the managers at

the headquarters of multinational corporations (principals) and the managers that
run the subsidiaries of multinational corporations (agents). The agency
relationships are created between the headquarters and subsidiaries of multinational
corporations because the interests of the managers at the headquarters who are
responsible for the performance of the whole organisation can be considerably
different from the interests of the managers that run the subsidiaries.

The incongruence of interests between the multinationals’ headquarters and

subsidiaries can arise not only due to concerns that can be seen in any parent-
subsidiary relationship but also due to the fact that the multinationals’ headquarters
and subsidiaries operate in different cultures and have divergent backgrounds.

Solutions to the agency problems in multinational companies

Board of directors
One way of addressing the problem is to separate the ratification and monitoring of
managerial decisions from their initiation and implementation. Boards of directors,
which consist of top-level executives of firms and non-executive outside members,
are institutions that carry out the role of ratifying and monitoring the managerial
decisions with the help of their non-executive outside members.

Managerial compensation packages

Managerial compensation package can be used to reduce agency costs in aligning
the interests of top executives with shareholders and the interests of subsidiary
managers to those of head office.

(C)
(i) Mongi’s Strategy [TZS Appreciation]
Strategy: Lagging payment to UK Supplier:
If the TZS appreciates against the sterling the company will adopt a lagging
approach.
• Cost of £ 5000 with at current rate: £5,000 x TZS3, 170/£ TZS15,850,000
• Cost of E 5000 with 2% Appreciation of the TZS
Appreciation: TZS.3170 – TZS.3170 (0.02)
• TZS.3170 – TZS.63.4
= TZS.3106.6

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 Cost = £5000 x TZS.3106.6/£ = TZS.15,533,000
Benefit/Cost saving TZS.15,850,000 –
TZS.15,533,000
=TZS.317,000

(ii) Mongi's Strategy [TZS Depreciation]

Strategy: Leading Payment to UK Supplier:
If the TZS depreciates against the sterling the company will adopt a lagging
approach. One Month’s Time Cost of E5000: 2% Depreciation of TZS. (Leading)
– Pay Now!
• Cost of #5000 of current rate of TZS 3170/#
= TZS.15,850,000

• With 2% Depreciation: TZS

Cost of#5000 X [TZS 3170 + TZS 63.4]/£
=#5000 X TZS 3233.4/£= TZS 16, 167,000
Benefit/Cost saving = TZS.16,167,000 – TZS.15,850,000
= TZS.317,000

(iii) Limitation of Leading and Lagging Payments

Leading
Companies should be aware of the potential finance costs associated with paying
early. This is the interest cost on the money used to make the payment, but early
settlement discounts may be available. Thus, before deciding on a strategy of
making advanced payments, the company should compare how much it saves in
terms of currency with the finance costs of making early payment.

Lagging
By delaying payments there may be a loss of goodwill from the supplier which may
result in tighter credit terms in the future. While savings may have been made by
paying late, the company must compare these savings with potential future costs
resulting from, for example, withdrawal of favorable credit terms and early
settlement discounts.

ANSWER 3
(a)
(i). Justification for investing in high-risk economies.
➢ Often, they come with very high returns which can justify taking the risk.
➢ Long term forms – hoping that things will turn around in the future.
➢ Political support – to support political interest of the host or foreign economies
control sensitive resources.
(ii). Risks
➢ Mosty security related which can also increase costs.
➢ Expropriation of assets.
➢ Limited remittance of funds
➢ Bureaucracy and corruption.

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 Dealing with political risks
There are various strategies that multinational companies can adopt to limit the
effects of political risk.
Negotiations with host government
The aim of these negotiations is generally to obtain a concession agreement. This
would cover matter such as the transfer of capital, remittance and products, access
to local finance, government intervention and taxation and transfer pricing.
Insurance
Some countries, provides to their citizens protection against various threats,
including nationalisation, currency conversion problems, war and revolution.

Production strategies
It may be necessary to strike a balance between contracting out to local sources
(thus losing control) and producing directly (which increases the investment and
therefore the potential loss). Alternatively, it may be better to locate key parts of
the production process or the distribution channels abroad. Control of patents is
another possibility, since these can be enforced internationally.

Financial management
If a multinational obtains funds in local investment markets, these may be on terms
that are less favorable than on markets abroad, but would mean that local
institutions suffered if the local Government intervened. However, government
often do limit the ability of multinationals to obtain funds locally.

(b)(i) Assessing the Economic Viability of the Tanzania project

Tanzania project appraisal: Centralized Capital Budgeting
End of the year 0 1 2 3
Initial cash Inv (TZS) (24,000) - - -
Net operating cash Flows - 20,000 20,000 10,000
Net cash Flows (24,000) 20,000 20,000 10,000
Expects Ex. Rate: TZS/£ 3,000 3,029 3,057 3,087
Net cash Flows: £m (8.0) 6.6 6.5 3.2
Discount Factor 1 0.870 0.756 0.658
Present Value (8.0) 5.7 4.9 2.1

NPV£ = £12.7m - £8m = £4.7m

Adjusted Discount Rate = (1 + rtzs) (1 + Risk Premium)
= (1.06) (1.0952) – 1
= 16.1%
Workings:
Forecast Exchange Rates
Year 1: e1 = TZS.3000 (1.06)/(1.05)= TZS.3028.6
Year 2: e2 = TZS.3000 (1.06)2/(1.05)3= TZS.3057.4
Year 3: e3 = TZS.3000 (1.06)3/(1.05)3= TZS.3086.5
Initial Investment: £8m x TZS3000/£ = TZS.24,000m
Adjusted Discount Rate = (1 + rrzs) (1 + Risk Premium) – 1
Rate Premium + 1.15/1.05 – 1 = 0.0952

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Tanzania Project Appraisal: Decentralized Capital Budgeting
End of Year 0 1 2 3
Net Cash Flows (TZSm) (24,000) 20,000 20,000 10,000
Disc Factor (at 16.1%) 1 0,861 0.742 0.639
Present Value (TZSm) (24,000) 17,220 14,840 6.390

NPVTZS = [17220 + 14840 = 6390] – 24000

= TZS.38450 – TZS.24000
= TZS.14,450m
NPV = NPVtzs /TZS.3000/£
= £ 4.8m
Comment: The project is economically viable when using either of the approaches.

(ii) Reasoning for two approaches to give almost identical answers

The two approaches give identical answers as the exchange rate has been estimated
using the IFE, which links inflation rate differenced to interest rate and exchange
rate. The second approach adjusts the discount rate to 16.1% and keeps the
exchange rate constant at TZS.3,000.

ANSWER 4

(a) MNC using cryptocurrencies

Using cryptocurrencies in conducting international business can offer several
benefits to multinational corporations:
i. Faster and Cheaper Transactions: Cryptocurrency transactions are typically
faster and more cost-effective than traditional banking systems. MNCs can
avoid delays and high transaction fees associated with cross-border transfers,
leading to improved cash flow and reduced financial costs.
ii. Enhanced Security and Privacy: Cryptocurrencies operate on a decentralized
blockchain, providing a high level of security and privacy for transactions.
This can be particularly beneficial for MNCs handling sensitive financial
information and trade secrets, reducing the risk of data breaches and fraud.
iii. Access to New Markets: Accepting cryptocurrencies as a mode of payment
can open up new markets and opportunities for MNCs. It allows businesses
to reach customers in regions where traditional banking services are limited
or inaccessible.
iv. Elimination of Currency Conversion Costs: Cryptocurrencies are borderless,
eliminating the need for currency conversions in international transactions.
This can be advantageous for MNCs dealing with multiple currencies and can
lead to cost savings and simplified financial operations.
v. Improved Transparency and Auditability: Blockchain technology, which
underpins cryptocurrencies, offers a transparent and immutable record of all
transactions. This transparency enhances trust among stakeholders and
simplifies auditing processes for the corporation.

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 vi. Financial Inclusion: Cryptocurrencies can facilitate financial inclusion in
regions with underdeveloped banking infrastructure. MNCs using
cryptocurrencies can support economic growth and foster financial
participation in these areas.

vii. Innovation and Technological Adoption: Embracing cryptocurrencies

demonstrates a commitment to innovation and technology adoption. This can
enhance the brand image of the MNC and attract customers and investors who
value forward-thinking approaches.

viii. Reduce Exchange Rate Risk: Using cryptocurrencies can mitigate exchange
rate for MNCs, as transactions are conducted directly in the cryptocurrency
without involving volatile fiat currencies.
(b)

R Q
Domestic 16% 22% Ƿ = +0.6
Foreign 19% 24%

(i) Foreign has higher risk but also higher return hence consistent with risk return
trade off.
As Abacus takes in foreign to risks – weighted return will increase because
𝐸𝑅𝑃 = 𝑊𝑎 𝑅𝑎 + 2𝑊𝑏 𝑅𝑏 . linear with 𝑊𝑏 . However, the variability will
decrease since

√𝜎𝑃 = (𝑊𝑎2 𝜎𝑎2 + 𝑊𝑏2 𝜎𝑏2 + 2𝑊𝑎 𝑊𝑏 𝜎𝑎 𝜎𝑏 (𝑎𝑏) and

the coefficient of correlation is less than 1.0

(ii) When 𝑊𝐷 = 70% and 𝑊𝐹 = 30%

𝑅𝑝 = 0.70 (16%) + 0.3 (19%) = 16.9%
𝜎𝑝 = [(0.70)2 (0.22)2 + (0.3)2 (0.24)2 + 2 0.7 x 0.3 x 0.22 x 0.24] ½ = 20.
54%

(iii) When 𝑊𝐷 = 40% and 𝑊𝐹 = 60%

𝑅𝑞 = 17.8%
𝜎𝑝 = 20.71%

𝑅𝑝 increase as WF increases. However, 𝜎𝑝 decreases then increases as WF

𝜕𝜎⁄
increases. Lowest 𝑅𝑝 is obtained by 𝜕𝑊⁄𝑃 which gives approximately 𝑊𝐹 =
𝐹
38.6% 𝑊𝐷 = 61.4%

(iv) Abacus should choose the range of 𝑊𝐹 = 38.6% and 100%. This is the efficient
frontier where 𝜎𝑝 no longer decreases.

𝑊𝐹 of 0 to 38.6% is not ideal for abacus since in this rate return increases while risk
fact at the
Same time.

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 The exact choice of the point between 38.6% and 100% of depends on abacus choice
risk and

Return since in this range both risk and return increase which us consistent with the
risk- return
Trade off.

ANSWER 5

(a)

Bid Ask
Given Sport US$/£ 1.7130 1.7190
Add: discount 0.0200 0.0800
1 Month form U$/# 1.7330 1.7990
1 Month spot Forecast 1.9130 1.9190

(i) Illustration: Forward – Spot Speculation

STEPS:
1. Buy £1,000,000 one month forward at US$ 1.7990/£
Purchase cost = £1,000,000 x US$1.7990/£
= US$ 1,799,000

2. Sell the £1,000,000 one month later at the forecast spot rate of US$1.9130/# should
that turn out to be true.
Expected Revenue = £1m x US$ 1.9130/£
= US$1, 913,000
Expected Profit = US$ 1,913,000 – US$ 1,799,000
= US$ 114,000

(ii) Actual loss: Exchange Rate #: US$ 1.7140 – 80

Actual loss = Actual Revenue – purchase Cost
= (£1m x US$1. 7140/£) – US$ 1,799,000
= US$ 1,714,000 – US$ 1,799,000
= US$ 85,000

(b) Forward and future contract

Future Forward
➢ Standardized in denomination/ amount and time Variable amount/ tenure
tenure.
➢ Tradable in organized markets - LIQUID OTC
➢ Speculative tools rather than just for hedging Can be failure tom suit the needs

The suitability depends on:

➢ The objective/need e.g. speculation is hedging
➢ The available of counterparts

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(c) (i) Shushu would wish to get a share exchange deal which will increase their
effective EPS and not just (and not just nominal ERS, based on Shushu P/E ratio the
20
shares at TZS.300 are undervalued vs nominal of TZS.307.70 [𝑖. 𝑒 (1.3 𝑥 20)] Ratio
1:1.667 to 1.625
Value wise the offer of 10:13 (1:1.3) is better than the current valuation.

To: Chairman of the Board

From: Financial Advisor
RE: Report on Takeover of Shushu plc

Implication of Takeover an EPS and APS: Paparazi plc

Implication of takeover on EPS

• Current EPS (Before Takeover) = Total Earnings/Number of shares =

TSZ.40/2m
= TZS.20

• EPS after Takeover = Combination Earnings/Combined No of Shares

TZS.40m + TZS.20m(2m + 1m) = TZS.60m/3m =TZS.20
*EPS will not be affected!
Implications of Takeover on APS

• Current APS (Before Takeover) Total Assets/ No. of shares

= TZS.400m/2m
= TZS.200

APS After the Takeover

APS = Combined Assets Value/No. of shares
= [TZS.400m + TZS.200]
= TZS.600m/3m
= TZS.200
Thus, APS will not be affected!

Note: No. of Shares issued to Shushu Plc’s Shareholder 10:13

= 1,300,000/13 x 10
= 1,000,000 Shares

Implication of Takeover an EPS and APS: Shushu Plc

Implication of Takeover on EPS

Current EPS = TZS.20m/1.3m = TZS 15.40
New EPS = TZS.20

As Shareholder of Shushu Plc will receive 1,000,000 shares in exchange for their
1,300,000 shares their total earning in Paparazi Plc will be:
TZS.20 x 1,000,000 i.e., TZS.2,000,000
Thus, no change in items of earning to the shareholder will occur.

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 Implication of Takeover on APS
APS Before Takeover = 200m/1.3m = TZS.153.85
APS After Takeover = TZS.200

The APS will increase however on the 1,000,000 shares issue to Shushu Plc
Shareholders their asset backing remains to be the same i/e. TZS.200 x 1,000,000 =
TZS. 200m
(ii) Advice
Shareholders of Shushu Co. will not gain through the takeover bid in terms of both
Earning and Asset Backing. Their status will not change. Accepting the takeover bid
is not recommended.

ANSWER 6

(a) FDI

Foreign Direct Investment (FDI) can have significant impacts on the economic
growth and development of host countries. Here are some key ways in which FDI
influences their economies:

l. Increased Capital Investment: FDI brings in foreign capital, which helps in

funding new projects, expanding existing businesses, and upgrading
infrastructure. This influx of capital boosts investment levels in the host
country, leading to economic growth and development.

2. Job Creation: When foreign investors set up operations in the host country,
they create job opportunities for the local workforce. This leads to reduced
unemployment rates and an increase in disposable income, which can further
drive economic growth through increased consumer spending.

3. Technology Transfer: Multinational corporations often bring advanced

technologies, managerial expertise, and best practices to the host country.
This technology transfer enhances the productivity and efficiency of local
industries, making them more competitive in the global market.

4. Access to Global Markets: FDI can enable host countries to gain access to
international markets and global supply chains. Foreign investors may use
their established networks to export local products to other countries, which
can increase the host country's exports and foreign exchange earnings.

5. Spillover Effects: FDI can lea4 to spillover effects, where the knowledge and
skills of foreign investors and their employees spread to the local workforce
and businesses. This can result in improved human capital and increased
innovation, benefiting the overall economy.

6. Infrastructure Development: FDI often necessitates infrastructure

improvements to support the operations of foreign investors. As a result,
host countries may see enhancements in transportation, communication, and
energy infrastructure, which can have a positive impact on economic
development.

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 7. Foreign Exchange Inflows: FDI brings foreign currency into the host
country, which can strengthen its foreign exchange reserves. This can provide
stability to the local currency and increase the country's capacity to import
goods and services.

8. Linkages and Clusters: FDI can create linkages and clusters within
industries, where suppliers, buyers, and other related businesses are attracted
to the presence of foreign investors. This can foster the development of a well-
integrated and efficient industrial ecosystem.

(b) (i): Share Intrinsic Value and Value of Charambe Co.: Dividend Growth Model
(December 2021)
Provided the future dividend growth rate is expected to be similar to the historic
dividend growth rate, the dividend growth rate of 10% can be used in the dividend
growth model.
The share intrinsic value is therefore: PO = (TZS.616 x 1.1)/(0.205 - 0.1) =
TZS.6,453.3

As the actual market price is TZS.8,400 (higher than the intrinsic value,
TZS.6,453.3 the share is evidently overvalued.

Equity Intrinsic Value TZS.6,453.3 x 100,000 = TZS.645,330,000

(ii): Share Intrinsic Value and Value of Charambe Co.: Earnings Yield Model
(December 2021)
Provided the future earnings growth rate is expected to be similar to the historic
earnings growth rate, the dividend growth rate of 10% can be used in the earnings
yield model.

The share intrinsic value is therefore: PO = (TZS.616 x 1.1 )/(0.205 – 0.1) =

TZS.6,453.3

The EPS = TZS.154m/100,000 = TZS.1,540

The share intrinsic value is therefore: Po = (TZS.1,540 x 1.1)/(0.182 – 0.1)
= TZS.1,694/0.082
= TZS.20,658.5

As the actual market price is TZS.8,400 (less than the intrinsic value, TZS.20,658.5
the share is evidently undervalued.
Equity Intrinsic Value = TZS20,658.5 x 100,000 = TZS2,065.85m

(iii): The relative merits of the dividend growth model and the earnings yield
method as a way of valuing Charambe Co.
Cash-flow valuation models tend to be preferred to profit-based valuation models
and so the dividend growth model (DGM) could be preferred to the earnings yield
method (EY M), as the DGM uses cash, while the E YM uses profit.

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 The DGM has used information specific to Charambe Co, whereas the earnings
yield method has used an average earnings yield relating to companies which are
similar to Charambe Co. The DOM valuation is therefore, likely to be more
relevant to Charambe Co than the EYM valuation, as Charambe Co is likely to be
different from the average company in its business area.

The two valuation methods relate to different valuation purposes in an acquisition

context. The dividend growth model values a minority shareholding in a target
company, while the earnings yield valuation gives a value from the perspective of
the acquirer, provided the earnings yield used is appropriate.

Both the DGM and the EYM assume that relevant valuation variables, such as the
dividend growth rate, the cost of equity and the earnings yield, will remain constant
in the future in perpetuity. This is very unlikely to be true and reduces the
usefulness if two valuation methods.

______________ ▲ _______________

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