PROFESSIONAL PROGRAM – Page 78

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

FM – L2 – Q15 – Business valuations

Estimate market value of irredeemable 7.5% bonds with 9% required return.

Question

Assume that bond investors in Ama Industries require a return of 9% per year on their investments.

Required:

(A) Estimate the market value of irredeemable 7.5% bonds that pay interest annually.

(B) Estimate the market value of bonds paying coupon interest of 6% per year annually, that are redeemable at par in four years’ time.

(C) Estimate the market value of bonds paying coupon interest of 10%, redeemable at par after three years, where interest is payable every six months.

(D) Estimate the market value of a convertible bond with a coupon of 5% and interest payable annually; these bonds are convertible after three years into equity shares at the rate of 20 shares for every GH₵100 nominal value of bonds. The expected share price in three years’ time is GH₵7.

Answer

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Tags: Bond valuation, Business valuations, Interest rate, Irredeemable bonds
Level: Level 2

Topic: Business valuations

MA – L2 – Q62 – Divisional performance

Calculate ROI for a new investment project at Kumasi Tech Ltd over three years.

Question

Kumasi Tech Ltd is organised into several investment centres. The annual performance of each investment centre is measured on the basis of ROI. ROI is measured each year as the profit before interest as a percentage of the average investment/average capital employed in the investment centre.
One of the investment centres has achieved a ROI in excess of 35% in each of the past four years. Its managers are considering a new investment project that will have the following cash flows:

Year	Cash flow
Beginning of Year 1	(42,000)
1–3	19,000 each year

The initial investment will be in an item of machinery that will have no residual value at the end of Year 3. Assume that depreciation is charged on a straight-line basis.
Required:
(a) Calculate the ROI for the project, each year and on average for the three-year period.

(b) Suggest whether the managers of the investment Centre are likely to invest in the project.

Answer

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Tags: Depreciation, Divisional performance, Investment centre, Performance Measurement, ROI
Level: Level 2

Topic: Divisional performance

FM – L2 – Q14 – Business valuations

Calculate expected share price using dividend valuation model with constant dividends of GH₵0.24 in perpetuity.

Question

Kofi Enterprises has shareholders expecting an 8% annual return. The company paid dividends of GH₵0.24 per share in the year just ended.

Required:

(A). Assume that Kofi Enterprises pays out all of its annual profits as dividends, and the annual dividend per share is expected to be GH₵0.24 in perpetuity. Using the dividend valuation model, suggest what the expected share price of the company should be.

(B). Assume that the expected annual rate of growth in dividends is expected to be 3%. Using the dividend growth valuation model, suggest what the expected share price of the company should be.

(C). Assume that Kofi Enterprises is expected to retain 60% of its profits and reinvest the money to earn an annual return of 9%. Using the dividend growth valuation model (the Gordon growth model), suggest what the expected share price of the company should be.

Answer

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Tags: Business valuations, dividend valuation, Perpetuity, share price
Level: Level 2

Topic: Business valuations

FM – L2 – Q13 – Portfolio theory and CAPM

Calculate the expected return on shares with a beta of 1.2, given risk-free rate of 15% and market return of 20%.

Question

Unity Ventures have shares in a company which paid a dividend of GH¢10 to its shareholders. The shares have a beta factor of 1.2. The risk-free rate of return and the market return are 15% and 20% respectively.

Required:

(a) Calculate the return on the shares.

(b) Calculate the value of the shares.

Answer

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Tags: dividend valuation, expected return, share price
Level: Level 2

Topic: Business valuations

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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.

FM – L2 – Q15 – Business valuations

Estimate market value of irredeemable 7.5% bonds with 9% required return.

MA – L2 – Q62 – Divisional performance

Calculate ROI for a new investment project at Kumasi Tech Ltd over three years.

FM – L2 – Q14 – Business valuations

Calculate expected share price using dividend valuation model with constant dividends of GH₵0.24 in perpetuity.

FM – L2 – Q13 – Portfolio theory and CAPM

Calculate the expected return on shares with a beta of 1.2, given risk-free rate of 15% and market return of 20%.

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

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

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

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

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Define an optimal transfer price for Keta Shelving Limited.

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

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Estimate market value of irredeemable 7.5% bonds with 9% required return.

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Calculate ROI for a new investment project at Kumasi Tech Ltd over three years.

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Calculate expected share price using dividend valuation model with constant dividends of GH₵0.24 in perpetuity.

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Calculate the expected return on shares with a beta of 1.2, given risk-free rate of 15% and market return of 20%.

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