Level 2 – Page 32

MA – L2 – Q66 – Performance Analysis

Evaluate if Ashanti Pharmaceuticals Ltd is on track for growth, analyzing sales, profit, and employee productivity from Year 1 to Year 2.

Question

Ashanti Pharmaceuticals Ltd has an objective in its long-term business plan of achieving significant growth in its business in the period Year 1 to Year 5. It is now the end of Year 2.

Its results for the years to 31st December Year 1 and Year 2 are summarised below.

Statement of profit or loss for the year ended 31 December

	Year 2 (GH₵)	Year 1 (GH₵)
Sales	31,200,000	26,000,000
Cost of sales	18,720,000	15,600,000
Gross profit	12,480,000	10,400,000
Operating costs	6,780,000	5,200,000
Interest charges	500,000	–
Taxation	3,000,000	3,000,000
Net profit	2,200,000	2,200,000

Statement of financial position as at 31st December

	Year 2 (GH₵)	Year 1 (GH₵)
Non-current assets	27,300,000	26,000,000
Net current assets	15,600,000	7,800,000
Total assets	42,900,000	33,800,000
Borrowings	9,000,000	–
Net assets	33,900,000	33,800,000
Share capital and reserves	19,500,000	19,500,000
Retained earnings	14,400,000	14,300,000
Total equity	33,900,000	33,800,000

Sales are seasonal, and are much higher in the first six months of the year than in the second six months. The half-yearly sales figures in the past two years have been as follows:

Sales

	Year 2 (GH₵)	Year 1 (GH₵)
First six months	21,645,000	16,900,000
Second six months	9,555,000	9,100,000
Total	31,200,000	26,000,000

The company employs part-time workers during the first six months of each year. Part-time workers operate for a full working week during the weeks that they are employed. Employee numbers have been as follows:

Employee numbers

	Year 2	Year 1
Full-time	318	260
Part-time (first six months)	494	310

The company introduced four new products to the market in Year 1 and another five new products in Year 2.

Required:
Explain with reasons whether the company appears to be on course for achievement and production.

Answer

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Tags: Employee Productivity, Financial Performance, Non-financial performance, Performance Analysis, Sales Growth, Working Capital
Level: Level 2

Topic: Performance Analysis

MA – L2 – Q65 – Transfer Pricing

Prepare profit statements for Kumasi Construction Materials Ltd at 80% and 100% capacity with transfer prices of GH₵200 and GH₵180.

Question

Kumasi Construction Materials Ltd is organised into two trading divisions. Division A makes materials that are used to manufacture special bricks. It transfers some of these materials to Division B and sells some of the materials externally to other brick manufacturers. Division B makes special bricks from the materials and sells them to traders in building materials.

The production capacity of Division A is 2,000 tonnes per month. At present, sales are limited to 1,000 tonnes to external customers and 600 tonnes to Division B.

The transfer price was agreed at GH₵200 per tonne in line with the external sales trade price at 1st July which was the beginning of the budget year. From 1st December, however, strong competition in the market has reduced the market price for the materials to GH₵180 per tonne.

The manager of Division B is now saying that the transfer price for the materials from Division A should be the same as for external customers. The manager of Division A rejects this argument on the basis that the original budget established the transfer price for the entire financial year.

From each tonne of materials, Division B produces 1,000 bricks, which it sells at GH₵0.40 per brick. It would sell a further 400,000 bricks if the price were reduced to GH₵0.32 per brick.

Other data relevant are given below:

Division A	Division B
GH₵	GH₵
Variable cost per tonne	70
Fixed cost per month	100,000

The variable costs of Division B exclude the transfer price of materials from Division A.

Required:
(a) Prepare estimated profit statements for the month of December for each division and for Kumasi Construction Materials Ltd as a whole, based on transfer prices of GH₵200 per tonne and of GH₵180 per tonne, when producing at
(i) 80% capacity
(ii) 100% capacity, on the assumption that Division B reduces the selling price to GH₵0.32.

(b) Comment on the effect that might result from a change in the transfer price from GH₵200 to GH₵180.

(c) Suggest an alternative transfer price that would provide an incentive for Division B to reduce the selling price and increase sales by 400,000 bricks a month.

Answer

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Tags: Capacity Utilization, Divisional performance, Internal Transfers, Profit Statements, transfer pricing
Level: Level 2

Topic: Divisional performance, Transfer pricing

FM – L2 – Q23 – Portfolio theory and CAPM

Calculate mean and standard deviation of expected return for Security X based on economic states.

Question

An investor is planning to invest in two securities, Security X and Security Y. The expected return from each security will depend on the state of the economy, as follows:

State of the economy	Probability	Return from Security X	Return from Security Y
Strong	0.25	15%	20%
Fair	0.60	10%	8%
Weak	0.15	2%	(6%)

Required:
(a) Calculate the mean and standard deviation of the expected return from Security X.

(b) Calculate the mean and standard deviation of the expected return from Security Y.

Cov_x,y = Σ p (x – x̄)(y – ȳ)

(d) Calculate the correlation coefficient for returns from Security X and Security Y, for a portfolio consisting of 50% of the funds invested in Security X and 50% of the funds invested in Security Y. The formula for correlation coefficient is:

ρ_XY = Covariance_XY / (σ_X σ_Y)

where:
σ_x = the standard deviation of returns from Security X
σ_y = the standard deviation of returns from Security Y
Cov_x,y = Covariance of X and Y

Comment on the correlation coefficient.

(e) Calculate expected return, the variance and standard deviation of a portfolio consisting of 50% of the funds invested in Security X and 50% of the funds invested in Security Y. The formula for correlation coefficient is: a²(Variance X)² + (1-a)²(Variance Y)² + 2a(1-a)Cov_x,y

where:
a = the proportion of the portfolio invested in Security X
(1-a) = the proportion of the portfolio invested in Security Y
Variance X = the variance of the returns from Security X
Variance Y = the variance of the returns from Security Y

(f) Calculate expected return, the variance and standard deviation of a portfolio consisting of 80% of the funds invested in Security X and 20% of the funds invested in Security Y.

Answer:

Answer

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Tags: expected return, Portfolio theory, Security X, Security Y, Standard deviation, Variance
Level: Level 2

Topic: Portfolio theory and the capital asset pricing model (CAPM)

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

Question

Tema Electrical Plc is considering whether to purchase a machine for the manufacture of a new product, Product X. It has been estimated that Product X would have a life of four years and at a selling price of GH¢8 per unit, annual sales demand would be 400,000 units in Year 1, 600,000 units in Year 2 and 800,000 in each of Years 3 and 4.

Variable production and selling costs would be GH¢6 per unit. Incremental annual fixed cost expenditures (all cash cost items) would be GH¢500,000 in Year 1, rising by GH¢20,000 each year.

The machine, which has an annual output capacity of 700,000 units of Product X, would cost GH¢1,200,000 and would have a resale value of GH¢200,000 at the end of Year 4. Capital allowances would be available on a 25% annual reducing balance basis, with a balancing charge or allowance in the year of disposal. Tax at 25% is payable one year in arrears of the profits to which it relates.

Tema Electrical Plc is financed 70% by equity capital and 30% by debt capital. The equity has a cost of 10% and the debt has a cost of 8.9% (before tax).

Required

Calculate the net present value of the proposed project and recommend whether the investment in the machine should be undertaken.

Answer

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Tags: capital allowances, Cash Flows, Cost of Capital, Discounted cash flow, Financial management, investment appraisal, NPV, project evaluation, Taxation, WACC
Level: Level 2

Topic: Discounted cash flow

MA – L2 – Q64 – Transfer Pricing

Evaluate transfer pricing objectives and calculate company contribution for Keta Fitness Ltd's divisions.

Question

KETA FITNESS LTD
(a) Objectives of Transfer pricing include the following:
(i) Goal congruence
(ii) Performance evaluation
(iii) Divisional authority
(iv) Tax minimisation
(v) Motivation
(b) The company’s contribution as a whole

	DIVISION A	DIVISION B	COMPANY
Selling price	GH₵ 20,000	GH₵ 30,000	GH₵ 30,000
Incremental Cost (A)	(12,000)	(20,000)	(12,000)
Incremental Cost (B)	–	(15,000)	(15,000)
Contribution	8,000	(5,000)	3,000

(i) Should Division A transfer to Division B or sell as an intermediate product?
(ii) If there is excess capacity of 200 units, what would be the total contribution and the range of transfer prices for the excess capacity?

Answer

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Tags: Contribution Analysis, Divisional performance, goal congruence, Internal Transfers, Motivation, Performance Evaluation, transfer pricing
Level: Level 2

Topic: Transfer pricing

FM – L2 – Q20 – Cost of capital

Calculate WACC using dividend growth model for cost of equity, given dividend, share price, and debt details.

Question

A company, Volta Ventures Ltd, has just paid an annual dividend of GH¢0.18. Investors expect the annual dividend to grow by 3% each year in perpetuity. The current share price is GH¢1.55, and the total market value of the company’s shares is GH¢1,200,000.

The company has debt capital on which the yield is 7.8% before tax. The rate of tax is 30%. The total value of the company’s debt is GH¢350,000.

Calculate the weighted average cost of capital. Use the dividend growth model to estimate the cost of equity.

Answer

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Tags: Cost of Equity, Debt Capital, Dividend Growth Model, Financial management, WACC
Level: Level 2

Topic: Cost of capital

FM – L2 – Q19 – Financial markets

Effect of NPV announcement on share price in a weak form efficient market.

Question

A company’s board of directors makes a decision on 1st May to invest in a new project that will have an NPV of + GH₵4,000,000. The decision is announced to the stock market on 12th May.

The company has 50 million shares in issue and at close of trading on 30th April these had a market value of GH₵4 each.

Required:

(A). State what would happen to the share price of the company if the stock market has weak form efficiency

(B) State what would happen to the share price of the company if the stock market has semi-strong form efficiency.

(C). State what would happen to the share price of the company if the stock market has strong-form efficiency.

Answer

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Tags: Efficient markets, NPV announcement, share price, Stock market, Strong form efficiency
Level: Level 2

Topic: Financial markets

FM – L2 – Q18 – Business valuations

Calculate the value of a zero coupon bond and an 8% coupon bond, both redeemable in 10 years, with a 5% investor yield.

Question

(a) Calculate the value of the following bonds:

(i) a zero coupon bond redeemable at par in ten years’ time

(ii) a bond with an 8% coupon, with interest payable half-yearly, and redeemable at par after ten years.

Assume that the yield required by investors is 5%, and that this is 2.5% each half year for the purpose of valuing the 8% coupon bond.

(b) Calculate the value of both bonds in part (a) of the question if the yield required by investors goes up by 1%, to 6% for the zero coupon bond and 3% each half year for the 8% coupon bond.

Answer

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Tags: Bond valuation, Coupon bond, Discounted cash flow, Yield change, Zero coupon bond
Level: Level 2

Topic: Business valuations

MA – L2 – Q63 – Transfer pricing

Define an optimal transfer price for Keta Shelving Limited.

Question

(A) Keta Shelving Limited, a company operating near Mount Adaklu, has two operating divisions, X and Y, that are treated as profit centres for the purpose of performance reporting.
Division X makes two products, Product A and Product B. Product A is sold to external customers for GH₵62 per unit. Product B is a part-finished item that is sold only to Division Y.
Division Y can obtain the part-finished item from either Division X or from an external supplier. The external supplier charges a price of GH₵55 per unit.
The production capacity of Division X is measured in total units of output, Products A and B. Each unit requires the same direct labour time. The costs of production in Division X are as follows:

	Product A	Product B
	GH₵	GH₵
Variable cost	46	48
Fixed cost	19	19
Full cost	65	67

Required:
(a) What is an optimal transfer price?

(b) What would be the optimal transfer price for Product B if there is spare production capacity in Division X?

(c) What would be the optimal transfer price for Product B if Division X is operating at full capacity due to a limited availability of direct labour, and there is unsatisfied external demand for Product A?

Answer

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Tags: Divisional performance, Full capacity, Opportunity cost, transfer pricing
Level: Level 2

Topic: Transfer pricing

FM – L2 – Q16 – Sources of finance: debt

Calculate value of convertible debentures and warrants for Amoah Plc and Bonsu Plc at expiry for given share prices.

Question

Amoah Plc and Bonsu Plc each have in issue 2,000,000 ordinary shares of GH₵1 nominal value.
Amoah Plc also has GH₵2,500,000 of 12% convertible debentures in issue. Each GH₵100 of bonds is convertible into 20 ordinary shares at any time until the date of expiry of the bonds. If the bonds have not been converted by the expiry date, they will be redeemed at 105.
Bonsu Plc has 500,000 equity warrants in issue. Each warrant gives its holder an option to subscribe for 1 ordinary share at a price of GH₵5.00 per share. The warrants can be exercised at any time until the date of their expiry.
The shares of both companies, the convertible debentures, and the warrants are all actively traded in the stock market.

Required
(a) Calculate the value of each GH₵100 unit of convertible debentures of Amoah Plc and the value of each warrant of Bonsu Plc on the day of expiry, if the share price for each company at that date is:
(i) GH₵4.40
(ii) GH₵5.20
(iii) GH₵6.00
(iv) GH₵6.80

(b) Assume that the profit before interest and tax of both companies is GH₵1,200,000 and the rate of tax is 50%.

Calculate the earnings per share for:

(i) Amoah Plc, assuming that none of the convertible debentures are converted

(ii) Amoah Plc, assuming that all of the convertible debentures are converted

(iii) Bonsu Plc, assuming that none of the warrants are exercised

(iv) Bonsu Plc, assuming that all of the warrants are exercised

Answer

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Tags: Earnings per share, Equity, Financial instruments, onvertible debentures, Profit after tax, Stock market, Warrants
Level: Level 2

Topic: Sources of finance: debt

Level (SQ): Level 2

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MA – L2 – Q66 – Performance Analysis

Evaluate if Ashanti Pharmaceuticals Ltd is on track for growth, analyzing sales, profit, and employee productivity from Year 1 to Year 2.

MA – L2 – Q65 – Transfer Pricing

Prepare profit statements for Kumasi Construction Materials Ltd at 80% and 100% capacity with transfer prices of GH₵200 and GH₵180.

FM – L2 – Q23 – Portfolio theory and CAPM

Calculate mean and standard deviation of expected return for Security X based on economic states.

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

MA – L2 – Q64 – Transfer Pricing

Evaluate transfer pricing objectives and calculate company contribution for Keta Fitness Ltd's divisions.

FM – L2 – Q20 – Cost of capital

Calculate WACC using dividend growth model for cost of equity, given dividend, share price, and debt details.

FM – L2 – Q19 – Financial markets

Effect of NPV announcement on share price in a weak form efficient market.

FM – L2 – Q18 – Business valuations

Calculate the value of a zero coupon bond and an 8% coupon bond, both redeemable in 10 years, with a 5% investor yield.

MA – L2 – Q63 – Transfer pricing

Define an optimal transfer price for Keta Shelving Limited.

FM – L2 – Q16 – Sources of finance: debt

Calculate value of convertible debentures and warrants for Amoah Plc and Bonsu Plc at expiry for given share prices.

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