WEDNESDAY: 26 April 2023. Morning Paper. Time Allowed: 3 hours.
Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings. Do NOT write anything on this paper.


1.  Distinguish between the following stages as per the industry life-cycle model:

“Embryonic stage” and “growth stage”. (4 marks)

“Shake out stage” and “decline stage”. (4 marks)

2.  Outline FOUR challenges involved with application of valuation standards in valuing private companies. (4 marks)

3.  The shares of Sabuni Ltd. are currently being sold at Sh.100 per share at the securities exchange. The firm currently yields a 10% book return on equity. At the end of the year, the firm is expected to pay Sh.4 dividend per share. It has been re-investing 40% of earnings and growing at a rate of 4% per year.
The management of Sabuni Ltd. plans to expand the firm gradually over five years in which it will have to re-invest 80% of its earnings for five years, however, starting in year 6, it will be able to pay out 60% of its earnings.


Determine the part of Sh.100 which is attributable to the present value of growth opportunities (PVGO).
(4 marks)

Calculate the firm’s share price after expansion plan announcement. (4 marks)

(Total: 20 marks)



1.  Outline THREE approaches to industry classifications as used in industry analysis. (3 marks)

2.  Enumerate THREE key differences between “fundamental analysis” and “technical analysis”. (3 marks)

3.  John Kiama has been tasked with developing a capital market expectations outlook including expected return on domestic equities and expected short term interest rates. He has gathered the following data:


Using the Grinold – Kroner model, estimate the expected return on domestic equities. (3 marks)

Using the Taylor rule, determine the target short term interest rate. (4 marks)

4.  Alice Wanjeri has gathered the following data and assumptions for Karambu Ltd.
Book value per share Sh.45.25
Market price per share Sh.126.05
Constant long term return on equity (ROE) 12%
Constant long term earnings growth rate 4.50%
Cost of equity 8.7%

Alice forecasts that the firm’s return on equity (ROE) will be higher than its long term ROE for the first three years. The forecasted earnings per share (EPS) and dividends per share (DPS) are shown below:

Starting in year 4, she forecasts the firm’s ROE to revert to the constant long term ROE of 12% annually. The terminal value is based on an assumption that residual income per share will be constant from year 3 into perpetuity.

Calculate the intrinsic value of the firm using the multistage residual income model. (7 marks)

(Total: 20 marks)



1.  Describe the following market pricing anomalies:

Calendar anomalies. (2 marks)

Momentum and overreaction anomalies. (2 marks)

Cross-sectional anomalies. (2 marks)

2. Monica Achieng’ has determined that at the beginning of year 2022, Bill Ltd. had total capital of Sh.324 million of which Sh.251 million was debt and Sh.73 million was equity. The company’s cost of debt before taxes is 7% and the cost equity capital is 8%. The net operating profit after tax before any adjustment is Sh.28,517,640 while the net income before the year is Sh.10,035,000. Monica also notes that the book value per share for Bill Ltd. at the beginning of year 2023 was Sh.4.29 and the current market price is Sh.70. She forecasts the return on equity for year 2023 to be 11.84%.
The corporate tax rate is 30%.

Calculate the firm’s:

Residual income. (3 marks)

Economic value added (EVA) for year 2022. (3 marks)

Implied residual income growth rate for the year 2023 based on the residual income model. (2 marks)

3. An investor is considering the following three stocks:

1. Stock A is expected to provide a free cash flow to the firm (FCFF) of Sh.10 per share to perpetuity.
2. Stock B is expected to earn free cash flow to the firm (FCFF) of Sh.5 per share next year. Thereafter, a
dividend growth rate is expected to be 4% per annum to perpetuity.
3. Stock C is expected to earn a FCFF of Sh.5 per share next year. Thereafter, FCFF growth rate is expected to be 20% per annum for 5 years and zero growth rate thereafter.
The required rate of return is 10%.

Determine the most valuable stock. (6 marks)

(Total: 20 marks)



1.  Summarise FOUR rationales for the use of price to cash flow in equity valuation. (4 marks)

2.  According to Michael Porter (1998), identify FIVE competitive forces that determine a firm’s ability to earn returns on capital in excess of cost of capital. (5 marks)

3. In the month of March 2022, Brent Ltd., share sold for Sh.73. Security analysts were forecasting a long term earnings annual growth rate of Sh.8.5%. The company was paying dividend of Sh.1.68 per share. James Kobia is interested in determining the required rate of return for the firm. He comes up with the following scenarios:

Scenario 1: The dividends are expected to grow along with the earnings at a rate of 8.5% per year in perpetuity.
Scenario 2: The firm is expected to earn about 12% on book equity and to pay out about 50% of earnings as dividends.



The rate of return under scenario 1. (2 marks)

The rate of return under scenario 2. (3 marks)

4.  Explain THREE methods of underwriting equity agreements. (6 marks)

(Total: 20 marks)



1.  Analyse the implications of efficient market hypothesis with respect to:

Technical analysis. (2 marks)

Fundamental analysis. (2 marks)

Portfolio management. (2 marks)

2.  Discuss TWO transactional considerations faced by controlling owner of a closely held business who wishes to liquidate his controlling interest. (4 marks)

3. A minority shareholder holds 10% of a private firm’s equity with the chief executive officer (CEO) holding the other 90%. Using normalised earnings method, the value of the firm’s equity is estimated at Sh.20 million. The CEO refuses to sell the firm and the minority shareholder cannot sell their interest easily. A discount for lack of marketability (DLOM) of 15% will be applied. Using reported earnings instead of normalised earnings provides an estimated firm equity value of Sh.19 million.

Calculate the value of the minority shareholders equity interest. (2 marks)

4.  Ujenzi Ltd. generates a return on equity (ROE) of 13% and pays out 50% of its earnings in dividends. The required rate of return for the firm is 10%.

Calculate the firms franchise price to earnings (P/E) ratio. (4 marks)

5. The management of Maadili Ltd. has announced the signing of a new marketing agreement that will allow the company to sell its products in Europe. An equity analyst is analysing the effect of this announcement on the estimated value of Maadili Ltd. equity.

The analyst uses the H-Model in his valuation process and has identified the following inputs:

1. Maadili Ltd. Free Cash Flow To Equity (FCFE) growth is expected to be 30% in the year 2023, declining over a five-year period to a constant growth rate of 12% in the year 2028 and thereafter.
2. The required rate of return for the firm is expected to be 13.5%.
3. The FCFE per share for the year 2022 was Sh.0.20.
4. The FCFE dividend payout ratio is expected to be constant.


Calculate the estimated value of a share of Maadili’s Ltd.’s equity on 31 December 2022. (4 marks)

(Total: 20 marks)

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