Question Tag: Acquisition

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  • 9 Marks

AT – Nov 2024 – L3 – Q2b – Tax Implications of 100% Acquisition in Mining Operations

Explain the tax implications of a 100% acquisition and compute the gains from the acquisition.

Tongo LTD (Tongo) is a mining company operating in the Upper East Region of Ghana. The following relates to the operations of Tongo for the 2023 year of assessment:

Description GH¢
Revenue (Gross) 200,000,000
Cost of Operations 80,000,000
Margin/Profit 120,000,000

Additional Information:

  1. Tempane Mines LTD acquired 100% interest in Tongo for a consideration of GH¢310,000,000 at the end of 2023.
  2. The cost of assets acquired at their respective acquisition dates are as follows:
Year Cost of Assets (GH¢)
2020 100,000,000
2021 75,000,000
2023 50,000,000

Required:

i) Explain the tax implication of the 100% acquisition.

ii) Compute the gains from the above acquisition and determine how the gains should be treated.

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  • 20 Marks

FM – May 2016 – L3 – Q4 – Mergers and Acquisitions

Estimating the additional equity value created by combining two companies and analyzing the impact of premium increases on shareholders.

Eko Product Plc (EP Plc) is a producer of a variety of vegetable oil and other household products in Lagos. The company presently faces significant competition in the market for one of its major raw materials – palm oil. To secure a regular flow of the raw material, the Directors of EP Plc are now considering making an offer for the entire share capital of Benin Oil Plc (BO Plc), a palm oil producing company in Benin.

The following financial information is provided for the two companies:

Parameter EP Plc BO Plc
Equity beta 1.2 1.2
Asset beta 0.9 1.2
Number of shares (million) 210 200
Current share price N29 N12

It is thought that combining the two companies will result in several benefits. It is estimated that combining the two companies will generate free cash flow to the firm (FCFF) of N1,080 million in current value terms, but these will increase by an annual growth rate of 5% for the next four years before reverting to an annual growth rate of 2.25% in perpetuity. In addition to this, combining the companies will result in cash synergy benefits of N100 million per year for the next four years. These synergy benefits are not subject to any inflationary increase, and no synergy benefits will occur after the fourth year.

The debt-to-equity ratio of the combined company will be 40:60 in market value terms and it is expected that the combined company’s cost of debt will be 4.55% before tax.

The income tax rate is 20%, the current risk-free rate of return is 2%, and the market risk premium is 7%. It can be assumed that the combined company’s asset beta is the weighted average of EP Plc’s and BO Plc’s asset betas weighted by their current market values.

EP Plc has offered to acquire BO Plc through a mixed offer of one of its shares for two BO Plc shares, plus a cash payment, such that a 30% premium is paid for the acquisition. Shareholders of BO Plc feel that a 50% premium would be more acceptable. EP Plc has sufficient cash reserves if the premium is 30%, but not if it is 50%.

You are required to:

(a) Estimate the additional equity value created by combining EP Plc and BO Plc based on the free cash flow to firm method. Comment on the results obtained and discuss briefly the assumptions made. (11 Marks)

(b) Estimate the impact on EP Plc’s equity holders if the premium paid is increased to 50% from 30%. (5 Marks)

c. Estimate the additional funds required if a premium of 50% is paid instead of 30% and discuss how this premium could be financed. (4 Marks)

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  • 4 Marks

ATAX – May 2016 – L3 – Q4a – Capital Gains Tax (CGT)

Define disposal and explain when an acquisition/disposal is considered effective under the Capital Gains Tax Act.

a. With respect to the Capital Gains Tax Act Cap C1 LFN 2004 (As Amended)
i. What is ‘Disposal’? (2 marks)
ii. When can an Acquisition/Disposal be said to be effective? (2 marks)

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  • 2 Marks

ATAX – May 2019 – L3 – Q4a – Capital Gains Tax (CGT)

Define when acquisition or disposal is effective under the Capital Gains Tax Act.

a. With respect to the Capital Gains Tax Act Cap C1 LFN 2004 (as amended), when is acquisition or disposal effective? (2 Marks)

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  • 8 Marks

CR – Nov 2014 – L3 – SC – Q4b – Income Taxes (IAS 12)

Evaluate the impact of deferred tax on fair value adjustments for property, plant, and equipment in an acquisition.

On 1 June 2013, Bam Plc acquired Mango Limited for N3,150 million.
The fair value of the identifiable net assets of Mango Limited at this date was N825 million, and N2,550 million and retained earnings and other components of equity were N105 million, respectively. Mango Limited’s share capital was N1,500 million.

The excess of the fair value of the net assets is due to an increase in the value of property, plant, and equipment.

Required:
Evaluate the impact of full deferred tax on the excess of the fair value of the net assets attributable to the increase in the value of property, plant, and equipment of Bam Plc.

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  • 30 Marks

FM – May 2024 – L3 – SA – Q1 – Business Valuation Techniques

Evaluate the potential acquisition of Kenny Ltd (KL) by Bolade Plc, calculating share value using various valuation methods, assessing these methods, and outlining merger benefits.

You are employed by Bolade Plc (BP), a very large printing firm with retail outlets across Nigeria. Its board is considering making an offer to buy 100% of the shares of Kenny Ltd (KL), a competitor of Bolade in Aba. KL’s financial year-end is 28 February, and its most recent financial statements are summarised below:

KL Income Statement for the Year Ended 28 February 2023

Item ₦m
Revenue 17.3
Profit before interest and tax 5.9
Interest (0.3)
Profit before taxation 5.6
Tax at 21% (1.2)
Profit after taxation 4.4
Dividends declared 1.1

KL Statement of Financial Position at 28 February 2023

Item ₦m
Non-current assets:
Freehold land and buildings (original cost ₦4.1m) 3.5
Machinery (original cost ₦8.8m) 5.3
Total Non-current assets 8.8
Current assets:
Inventories 3.0
Receivables 0.5
Cash and bank 2.8
Total Current assets 6.3
Current liabilities:
Trade payables 3.5
Dividends 1.1
Taxation 1.2
Total Current liabilities (5.8)
Net Current assets 0.5
Net assets 9.3
Non-current liabilities:
10% bonds (redeemable 2031) (3.0)
Net assets after non-current liabilities 6.3
Equity:
Ordinary shares of ₦1 each 2.1
Retained earnings 4.2
Total equity 6.3

Additional Information:

KL’s management had some of the company’s assets independently revalued in January 2023. Those values are shown below:

Asset ₦m
Freehold land and building 8.3
Machinery 4.1
Inventories 3.1

The average price/earnings ratio for listed businesses in the printing industry is 9, and the average dividend yield is 6% p.a.
The cost of equity of businesses in the printing industry, taking account of the industry average level of capital gearing, is 14% p.a.

KL’s finance department has estimated that the company’s pre-tax net cash inflows (after interest) for the next four trading years ending 28 February, before taking account of capital allowances, will be:

Year to ₦m
2024 4.6
2025 4.3
2026 5.2
2027 5.7

KL’s existing equipment has a tax written-down value of ₦3.6 million at 28 February 2023. The equipment attracts 18% (reducing balance) tax allowances in every year of ownership by the company, except the final year.

You should assume that KL will not be purchasing or disposing of any machinery in the years 2024-2027 and that it would dispose of the existing equipment on 28 February 2027 at its tax written-down value.

Bolade’s board estimates that in four years’ time, i.e., 28 February 2027, it could, if necessary, dispose of KL for an amount equal to four times its after-tax cash flow (ignoring the effects of capital allowances and the disposal value of the equipment) for the year to 28 February 2027.

Assume that the company income tax rate is 21% p.a.

Required:

Using the information provided, prepare a report for Bolade’s board by:

a. Calculating the value of one share in KL based on each of the following methods:

  • i. Net asset basis (historic cost)
  • ii. Net asset basis (revalued)
  • iii. Price/earnings ratio
  • iv. Dividend yield
  • v. Present value of future cash flows
    (16 Marks)

b. Explain the advantages and disadvantages of using each of the five valuation methods in (a).
(8 Marks)

c. What are the possible benefits from the merger between Bolade Plc (BP) and Kenny Limited (KL).
(6 Marks)

(Total: 30 Marks)

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  • 20 Marks

FM – Nov 2018 – L3 – Q3 – Business Valuation Techniques

Valuation of acquisition target using free cash flow forecast and P/E ratio analysis in the context of an acquisition.

Lagelu Plc. (LP) is a very successful entity. The company has consistently followed a business strategy of aggressive acquisitions, looking to buy companies that it believes were poorly managed and hence undervalued. LP can be described as a modern-day conglomerate with business interests stretching far and wide.

Its board of directors has chosen the takeover targets with care. LP has maintained its price earnings (P/E) ratio on the stock market at 12.2.

LP’s figures show a profit after tax of ₦4,430 million, and it has 375 million shares.

Lam Technical (LT) is a well-established owner-managed business. It has had its ups and downs in financial terms, corresponding directly with the state of the global economy. Since 2001, its profits have fallen each year, with the 2017 results as stated below:

With economists predicting an upturn in the global economy, LT’s management team feels that revenue will increase by 6% per annum up to and including year 2021. The company’s operating profit margin is not expected to change in the foreseeable future.

Operating profits are shown after deducting non-cash expenses (including tax-allowable depreciation) of ₦650m. This is expected to increase in line with sales. However, the company has recently spent ₦1,050m on the purchase of non-current assets, and LT’s management believes this will need to increase by 10% per annum until year 2021 to enable the company to remain competitive.

LT is currently financed by debt and equity. It has maintained a constant debt-to-total-asset ratio of 40% and has no intention to change this financing mix in the near future.

The company has a cost of equity of 17% and a weighted average cost of capital of 12%.

Assume a tax rate of 25% in all cases.

Some of LT’s major shareholders are not so confident about the future and would like to sell the business as a going concern. The minimum price they would consider would be the fair value of the shares plus a 10% premium. LT’s Chief Financial Officer believes the best way to find the fair value of the shares is to discount the forecast Free Cash Flows to the firm, assuming that beyond the year 2021, these will grow at a rate of 3% per annum indefinitely.

Required:

a. Prepare a schedule of forecast Free Cash Flows to the firm for each of the years from December 31, 2018, to 2021. (5 Marks)

b. Estimate the fair value of LT’s equity on a per-share basis. (6 Marks)

c. LP intends to make an offer to LT based on a share-for-share swap. LP will exchange one of its shares for every two LT shares. Assuming that LP can maintain its price earnings (P/E) ratio of 12.2, calculate the percentage gain in equity value that will be earned by both groups of shareholders. (6 Marks)

d. What factors should the LT shareholders consider before deciding whether to accept or reject the offer made by LP? (3 Marks)

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  • 20 Marks

CR – Nov 2018 – L3 – SB – Q3 – Business Combinations (IFRS 3)

Evaluation of Abana and Doha as potential acquisition targets using adjusted financial ratios.

Banny Plc. (Banny) is a diversified company that has achieved its present size through vertical and horizontal acquisition. The directors have identified two potential target entities for acquisition. The first is Abana Limited (Abana), which operates a cement business near Offa, Kwara State. The second is Doha Limited (Doha), also in the cement industry, located near Oturukpo, Benue State. Banny has obtained copies of their audited financial statements, along with additional information notes.

Statement of Profit or Loss for the Year Ended December 31, 2017

Item Abana (₦’m) Doha (₦’m)
Revenue 136,000 132,000
Cost of sales (84,000) (91,900)
Gross profit 52,000 40,100
Other operating expenses (36,000) (28,000)
Profit from operations 16,000 12,100
Finance costs (6,000) (8,000)
Profit before tax 10,000 4,100
Income tax expense (3,000) (2,000)
Net profit for the period 7,000 2,100

Statement of changes in equity for the year ended December 31, 2017

Statement of financial position as at December 31, 2017

Additional Notes:

  1. Doha revalued its non-current assets for the first time following IFRS adoption on January 1, 2017. Abana maintains its non-current assets at historical cost.
  2. Banny uses the following ratios to evaluate acquisition targets: Return on Capital Employed (ROCE), Gross Profit Margin, Turnover on Capital Employed, and Leverage.

Required:

a. Compute adjustments for the revaluation of property, plant, and equipment, making Abana and Doha comparable for analysis. (14 Marks)

b. Calculate the four ratios (ROCE, Gross Profit Margin, Turnover on Capital Employed, and Leverage) after adjustments. (4 Marks)

c. Advise Banny on the better acquisition target based on adjusted ratios. (2 Marks)

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  • 30 Marks

CR – Nov 2018 – L3 – SA – Q1a – Consolidated Financial Statements (IFRS 10)

Prepare a consolidated statement of financial position for Adegaga Laboratories Plc., including the effects of an acquisition and goodwill impairment.

Adegaga Laboratories Plc (“AdeLabs”) is one of the largest companies in Nigeria engaged in cosmetic development and manufacturing. Its largest customer base is in the healthcare sector for post-surgery patients and the Nigeria movie industry (aka Nollywood). In the prior financial period, AdeLabs’ expansion strategy has been largely focused on growth by acquisition and joint ventures.

Additional Information:

  1. As part of this, AdeLabs acquired 80% of the equity share capital of Bodegas Limited (“Bodegas”) on January 1, 2015, when the retained earnings of Bodegas was N93.75 million. Following the share acquisition, AdeLabs had control over Bodegas – no shares have been issued by Bodegas following the acquisition. The non-controlling interest in Bodegas was measured at its fair value of N20 million at the date of acquisition.
  2. On January 1, 2016, AdeLabs acquired 50% of the equity share capital of ChidePlastics Limited (“ChidePlast”) when the retained earnings of ChidePlast was N41.25 million. This acquisition was classified as a joint venture in accordance with IFRS 11 Joint Arrangements. ChidePlast has not issued any shares since the acquisition date.
  3. The balance on “other reserves” relates to movements in the values of investments in Bodegas and ChidePlast in the books of AdeLabs. N18.75 million relates to Bodegas, and the remainder to ChidePlast.
  4. AdeLabs’ non-current liabilities relate to a borrowing (long-term) taken out on January 1, 2017. This borrowing has an agreed coupon rate of 4% p.a., and the interest expense due in respect of 2017 has been paid and accounted for in profit for the year. The effective interest rate estimated with this financial liability is 8% p.a.
  5. As part of its annual impairment review, AdeLabs concluded that the goodwill on the acquisition of Bodegas was impaired by 20% at December 31, 2017. No other impairments of goodwill have arisen.
  6. AdeLabs sold goods to ChidePlast with a value of N75 million and a selling margin of 40% in November 2017. As at year-end December 31, 2017, 75% of these items are unsold.

Accounts for all companies are made up to December 31 annually.

Required:

Prepare for Adegaga Laboratories Plc:

  1. A consolidated statement of financial position as at December 31, 2017. (20 Marks)
  2. On January 1, 2018, AdeLabs acquired an additional 10% of the equity shares of Bodegas. The purchase consideration for this additional acquisition was N52,500,000.

    i. Briefly explain how this additional acquisition will impact the preparation of AdeLabs’ consolidated financial statements for the year ended December 31, 2017. (4 Marks)

    ii. Calculate the adjustment that will be required to be made to AdeLabs’ statement of financial position as a result of this acquisition. (6 Marks)

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  • 30 Marks

AAA – Nov 2022 – L3 – SB – Q1 – Group Audits

Evaluate the justification for joint auditors, present options for audit concerns, and prepare an appropriate report for disputed acquisition.

Mr. Johnson is the Senior Partner of Johnson, Odewole, Thomas & Co., Chartered Accountants. During the last audit of Mandarin Manufacturing Plc, which the firm did with Messrs Ark Professional Services (APS) for the year ended 30 September, 2020, Mr. Johnson expressed displeasure on some of the conclusions reached by APS on certain audit areas. The manager in charge of the audit at Johnson, Odewole, Thomas & Co. had drawn Mr. Johnson’s attention to matters marked “For Partner’s Attention.” Discussions with the corresponding partner of APS on these matters were considered unsatisfactory.

Mr. Johnson’s views differed significantly from those of the corresponding partner of APS. It was agreed to proceed to the board meeting where these disputed positions would be presented and discussed with the directors before a final decision was reached. Of significance is the acquisition of a property from a former staff member for the opening of a new branch warehouse. The acquisition process was hurried and exceeded the capital expenditure provisions for the period. Mr. Johnson’s team viewed the acquisition as a potential fraud on the company, while APS aligned with the director of finance, who considered it a normal transaction.

At the board meeting to discuss the financial statements, members were divided between the two audit firms’ views, leading the chairman to reschedule the meeting. He requested additional information on both parties’ positions and asked them to harmonize their views before the next meeting the following day.

Required:

a. Evaluate the justification or otherwise of an entity having joint auditors. (8 Marks)

b. Following the concerns of Johnson, Odewole, Thomas & Co., present the options available to the firm. (5 Marks)

c. Discuss the points on which the Chairman needs to base his decision, according to standard acquisition procedures. (7 Marks)

d. If the Chairman agrees with the position of Johnson, Odewole, Thomas & Co., determine the reporting requirement and draft an appropriate report for inclusion in the auditors’ report. (6 Marks)

e. Discuss the composition of items that could be marked “For Partner’s Attention” during the conclusion of an audit process. (4 Marks)

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  • 9 Marks

AT – Nov 2024 – L3 – Q2b – Tax Implications of 100% Acquisition in Mining Operations

Explain the tax implications of a 100% acquisition and compute the gains from the acquisition.

Tongo LTD (Tongo) is a mining company operating in the Upper East Region of Ghana. The following relates to the operations of Tongo for the 2023 year of assessment:

Description GH¢
Revenue (Gross) 200,000,000
Cost of Operations 80,000,000
Margin/Profit 120,000,000

Additional Information:

  1. Tempane Mines LTD acquired 100% interest in Tongo for a consideration of GH¢310,000,000 at the end of 2023.
  2. The cost of assets acquired at their respective acquisition dates are as follows:
Year Cost of Assets (GH¢)
2020 100,000,000
2021 75,000,000
2023 50,000,000

Required:

i) Explain the tax implication of the 100% acquisition.

ii) Compute the gains from the above acquisition and determine how the gains should be treated.

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  • 20 Marks

FM – May 2016 – L3 – Q4 – Mergers and Acquisitions

Estimating the additional equity value created by combining two companies and analyzing the impact of premium increases on shareholders.

Eko Product Plc (EP Plc) is a producer of a variety of vegetable oil and other household products in Lagos. The company presently faces significant competition in the market for one of its major raw materials – palm oil. To secure a regular flow of the raw material, the Directors of EP Plc are now considering making an offer for the entire share capital of Benin Oil Plc (BO Plc), a palm oil producing company in Benin.

The following financial information is provided for the two companies:

Parameter EP Plc BO Plc
Equity beta 1.2 1.2
Asset beta 0.9 1.2
Number of shares (million) 210 200
Current share price N29 N12

It is thought that combining the two companies will result in several benefits. It is estimated that combining the two companies will generate free cash flow to the firm (FCFF) of N1,080 million in current value terms, but these will increase by an annual growth rate of 5% for the next four years before reverting to an annual growth rate of 2.25% in perpetuity. In addition to this, combining the companies will result in cash synergy benefits of N100 million per year for the next four years. These synergy benefits are not subject to any inflationary increase, and no synergy benefits will occur after the fourth year.

The debt-to-equity ratio of the combined company will be 40:60 in market value terms and it is expected that the combined company’s cost of debt will be 4.55% before tax.

The income tax rate is 20%, the current risk-free rate of return is 2%, and the market risk premium is 7%. It can be assumed that the combined company’s asset beta is the weighted average of EP Plc’s and BO Plc’s asset betas weighted by their current market values.

EP Plc has offered to acquire BO Plc through a mixed offer of one of its shares for two BO Plc shares, plus a cash payment, such that a 30% premium is paid for the acquisition. Shareholders of BO Plc feel that a 50% premium would be more acceptable. EP Plc has sufficient cash reserves if the premium is 30%, but not if it is 50%.

You are required to:

(a) Estimate the additional equity value created by combining EP Plc and BO Plc based on the free cash flow to firm method. Comment on the results obtained and discuss briefly the assumptions made. (11 Marks)

(b) Estimate the impact on EP Plc’s equity holders if the premium paid is increased to 50% from 30%. (5 Marks)

c. Estimate the additional funds required if a premium of 50% is paid instead of 30% and discuss how this premium could be financed. (4 Marks)

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  • 4 Marks

ATAX – May 2016 – L3 – Q4a – Capital Gains Tax (CGT)

Define disposal and explain when an acquisition/disposal is considered effective under the Capital Gains Tax Act.

a. With respect to the Capital Gains Tax Act Cap C1 LFN 2004 (As Amended)
i. What is ‘Disposal’? (2 marks)
ii. When can an Acquisition/Disposal be said to be effective? (2 marks)

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  • 2 Marks

ATAX – May 2019 – L3 – Q4a – Capital Gains Tax (CGT)

Define when acquisition or disposal is effective under the Capital Gains Tax Act.

a. With respect to the Capital Gains Tax Act Cap C1 LFN 2004 (as amended), when is acquisition or disposal effective? (2 Marks)

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  • 8 Marks

CR – Nov 2014 – L3 – SC – Q4b – Income Taxes (IAS 12)

Evaluate the impact of deferred tax on fair value adjustments for property, plant, and equipment in an acquisition.

On 1 June 2013, Bam Plc acquired Mango Limited for N3,150 million.
The fair value of the identifiable net assets of Mango Limited at this date was N825 million, and N2,550 million and retained earnings and other components of equity were N105 million, respectively. Mango Limited’s share capital was N1,500 million.

The excess of the fair value of the net assets is due to an increase in the value of property, plant, and equipment.

Required:
Evaluate the impact of full deferred tax on the excess of the fair value of the net assets attributable to the increase in the value of property, plant, and equipment of Bam Plc.

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  • 30 Marks

FM – May 2024 – L3 – SA – Q1 – Business Valuation Techniques

Evaluate the potential acquisition of Kenny Ltd (KL) by Bolade Plc, calculating share value using various valuation methods, assessing these methods, and outlining merger benefits.

You are employed by Bolade Plc (BP), a very large printing firm with retail outlets across Nigeria. Its board is considering making an offer to buy 100% of the shares of Kenny Ltd (KL), a competitor of Bolade in Aba. KL’s financial year-end is 28 February, and its most recent financial statements are summarised below:

KL Income Statement for the Year Ended 28 February 2023

Item ₦m
Revenue 17.3
Profit before interest and tax 5.9
Interest (0.3)
Profit before taxation 5.6
Tax at 21% (1.2)
Profit after taxation 4.4
Dividends declared 1.1

KL Statement of Financial Position at 28 February 2023

Item ₦m
Non-current assets:
Freehold land and buildings (original cost ₦4.1m) 3.5
Machinery (original cost ₦8.8m) 5.3
Total Non-current assets 8.8
Current assets:
Inventories 3.0
Receivables 0.5
Cash and bank 2.8
Total Current assets 6.3
Current liabilities:
Trade payables 3.5
Dividends 1.1
Taxation 1.2
Total Current liabilities (5.8)
Net Current assets 0.5
Net assets 9.3
Non-current liabilities:
10% bonds (redeemable 2031) (3.0)
Net assets after non-current liabilities 6.3
Equity:
Ordinary shares of ₦1 each 2.1
Retained earnings 4.2
Total equity 6.3

Additional Information:

KL’s management had some of the company’s assets independently revalued in January 2023. Those values are shown below:

Asset ₦m
Freehold land and building 8.3
Machinery 4.1
Inventories 3.1

The average price/earnings ratio for listed businesses in the printing industry is 9, and the average dividend yield is 6% p.a.
The cost of equity of businesses in the printing industry, taking account of the industry average level of capital gearing, is 14% p.a.

KL’s finance department has estimated that the company’s pre-tax net cash inflows (after interest) for the next four trading years ending 28 February, before taking account of capital allowances, will be:

Year to ₦m
2024 4.6
2025 4.3
2026 5.2
2027 5.7

KL’s existing equipment has a tax written-down value of ₦3.6 million at 28 February 2023. The equipment attracts 18% (reducing balance) tax allowances in every year of ownership by the company, except the final year.

You should assume that KL will not be purchasing or disposing of any machinery in the years 2024-2027 and that it would dispose of the existing equipment on 28 February 2027 at its tax written-down value.

Bolade’s board estimates that in four years’ time, i.e., 28 February 2027, it could, if necessary, dispose of KL for an amount equal to four times its after-tax cash flow (ignoring the effects of capital allowances and the disposal value of the equipment) for the year to 28 February 2027.

Assume that the company income tax rate is 21% p.a.

Required:

Using the information provided, prepare a report for Bolade’s board by:

a. Calculating the value of one share in KL based on each of the following methods:

  • i. Net asset basis (historic cost)
  • ii. Net asset basis (revalued)
  • iii. Price/earnings ratio
  • iv. Dividend yield
  • v. Present value of future cash flows
    (16 Marks)

b. Explain the advantages and disadvantages of using each of the five valuation methods in (a).
(8 Marks)

c. What are the possible benefits from the merger between Bolade Plc (BP) and Kenny Limited (KL).
(6 Marks)

(Total: 30 Marks)

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  • 20 Marks

FM – Nov 2018 – L3 – Q3 – Business Valuation Techniques

Valuation of acquisition target using free cash flow forecast and P/E ratio analysis in the context of an acquisition.

Lagelu Plc. (LP) is a very successful entity. The company has consistently followed a business strategy of aggressive acquisitions, looking to buy companies that it believes were poorly managed and hence undervalued. LP can be described as a modern-day conglomerate with business interests stretching far and wide.

Its board of directors has chosen the takeover targets with care. LP has maintained its price earnings (P/E) ratio on the stock market at 12.2.

LP’s figures show a profit after tax of ₦4,430 million, and it has 375 million shares.

Lam Technical (LT) is a well-established owner-managed business. It has had its ups and downs in financial terms, corresponding directly with the state of the global economy. Since 2001, its profits have fallen each year, with the 2017 results as stated below:

With economists predicting an upturn in the global economy, LT’s management team feels that revenue will increase by 6% per annum up to and including year 2021. The company’s operating profit margin is not expected to change in the foreseeable future.

Operating profits are shown after deducting non-cash expenses (including tax-allowable depreciation) of ₦650m. This is expected to increase in line with sales. However, the company has recently spent ₦1,050m on the purchase of non-current assets, and LT’s management believes this will need to increase by 10% per annum until year 2021 to enable the company to remain competitive.

LT is currently financed by debt and equity. It has maintained a constant debt-to-total-asset ratio of 40% and has no intention to change this financing mix in the near future.

The company has a cost of equity of 17% and a weighted average cost of capital of 12%.

Assume a tax rate of 25% in all cases.

Some of LT’s major shareholders are not so confident about the future and would like to sell the business as a going concern. The minimum price they would consider would be the fair value of the shares plus a 10% premium. LT’s Chief Financial Officer believes the best way to find the fair value of the shares is to discount the forecast Free Cash Flows to the firm, assuming that beyond the year 2021, these will grow at a rate of 3% per annum indefinitely.

Required:

a. Prepare a schedule of forecast Free Cash Flows to the firm for each of the years from December 31, 2018, to 2021. (5 Marks)

b. Estimate the fair value of LT’s equity on a per-share basis. (6 Marks)

c. LP intends to make an offer to LT based on a share-for-share swap. LP will exchange one of its shares for every two LT shares. Assuming that LP can maintain its price earnings (P/E) ratio of 12.2, calculate the percentage gain in equity value that will be earned by both groups of shareholders. (6 Marks)

d. What factors should the LT shareholders consider before deciding whether to accept or reject the offer made by LP? (3 Marks)

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  • 20 Marks

CR – Nov 2018 – L3 – SB – Q3 – Business Combinations (IFRS 3)

Evaluation of Abana and Doha as potential acquisition targets using adjusted financial ratios.

Banny Plc. (Banny) is a diversified company that has achieved its present size through vertical and horizontal acquisition. The directors have identified two potential target entities for acquisition. The first is Abana Limited (Abana), which operates a cement business near Offa, Kwara State. The second is Doha Limited (Doha), also in the cement industry, located near Oturukpo, Benue State. Banny has obtained copies of their audited financial statements, along with additional information notes.

Statement of Profit or Loss for the Year Ended December 31, 2017

Item Abana (₦’m) Doha (₦’m)
Revenue 136,000 132,000
Cost of sales (84,000) (91,900)
Gross profit 52,000 40,100
Other operating expenses (36,000) (28,000)
Profit from operations 16,000 12,100
Finance costs (6,000) (8,000)
Profit before tax 10,000 4,100
Income tax expense (3,000) (2,000)
Net profit for the period 7,000 2,100

Statement of changes in equity for the year ended December 31, 2017

Statement of financial position as at December 31, 2017

Additional Notes:

  1. Doha revalued its non-current assets for the first time following IFRS adoption on January 1, 2017. Abana maintains its non-current assets at historical cost.
  2. Banny uses the following ratios to evaluate acquisition targets: Return on Capital Employed (ROCE), Gross Profit Margin, Turnover on Capital Employed, and Leverage.

Required:

a. Compute adjustments for the revaluation of property, plant, and equipment, making Abana and Doha comparable for analysis. (14 Marks)

b. Calculate the four ratios (ROCE, Gross Profit Margin, Turnover on Capital Employed, and Leverage) after adjustments. (4 Marks)

c. Advise Banny on the better acquisition target based on adjusted ratios. (2 Marks)

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  • 30 Marks

CR – Nov 2018 – L3 – SA – Q1a – Consolidated Financial Statements (IFRS 10)

Prepare a consolidated statement of financial position for Adegaga Laboratories Plc., including the effects of an acquisition and goodwill impairment.

Adegaga Laboratories Plc (“AdeLabs”) is one of the largest companies in Nigeria engaged in cosmetic development and manufacturing. Its largest customer base is in the healthcare sector for post-surgery patients and the Nigeria movie industry (aka Nollywood). In the prior financial period, AdeLabs’ expansion strategy has been largely focused on growth by acquisition and joint ventures.

Additional Information:

  1. As part of this, AdeLabs acquired 80% of the equity share capital of Bodegas Limited (“Bodegas”) on January 1, 2015, when the retained earnings of Bodegas was N93.75 million. Following the share acquisition, AdeLabs had control over Bodegas – no shares have been issued by Bodegas following the acquisition. The non-controlling interest in Bodegas was measured at its fair value of N20 million at the date of acquisition.
  2. On January 1, 2016, AdeLabs acquired 50% of the equity share capital of ChidePlastics Limited (“ChidePlast”) when the retained earnings of ChidePlast was N41.25 million. This acquisition was classified as a joint venture in accordance with IFRS 11 Joint Arrangements. ChidePlast has not issued any shares since the acquisition date.
  3. The balance on “other reserves” relates to movements in the values of investments in Bodegas and ChidePlast in the books of AdeLabs. N18.75 million relates to Bodegas, and the remainder to ChidePlast.
  4. AdeLabs’ non-current liabilities relate to a borrowing (long-term) taken out on January 1, 2017. This borrowing has an agreed coupon rate of 4% p.a., and the interest expense due in respect of 2017 has been paid and accounted for in profit for the year. The effective interest rate estimated with this financial liability is 8% p.a.
  5. As part of its annual impairment review, AdeLabs concluded that the goodwill on the acquisition of Bodegas was impaired by 20% at December 31, 2017. No other impairments of goodwill have arisen.
  6. AdeLabs sold goods to ChidePlast with a value of N75 million and a selling margin of 40% in November 2017. As at year-end December 31, 2017, 75% of these items are unsold.

Accounts for all companies are made up to December 31 annually.

Required:

Prepare for Adegaga Laboratories Plc:

  1. A consolidated statement of financial position as at December 31, 2017. (20 Marks)
  2. On January 1, 2018, AdeLabs acquired an additional 10% of the equity shares of Bodegas. The purchase consideration for this additional acquisition was N52,500,000.

    i. Briefly explain how this additional acquisition will impact the preparation of AdeLabs’ consolidated financial statements for the year ended December 31, 2017. (4 Marks)

    ii. Calculate the adjustment that will be required to be made to AdeLabs’ statement of financial position as a result of this acquisition. (6 Marks)

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  • 30 Marks

AAA – Nov 2022 – L3 – SB – Q1 – Group Audits

Evaluate the justification for joint auditors, present options for audit concerns, and prepare an appropriate report for disputed acquisition.

Mr. Johnson is the Senior Partner of Johnson, Odewole, Thomas & Co., Chartered Accountants. During the last audit of Mandarin Manufacturing Plc, which the firm did with Messrs Ark Professional Services (APS) for the year ended 30 September, 2020, Mr. Johnson expressed displeasure on some of the conclusions reached by APS on certain audit areas. The manager in charge of the audit at Johnson, Odewole, Thomas & Co. had drawn Mr. Johnson’s attention to matters marked “For Partner’s Attention.” Discussions with the corresponding partner of APS on these matters were considered unsatisfactory.

Mr. Johnson’s views differed significantly from those of the corresponding partner of APS. It was agreed to proceed to the board meeting where these disputed positions would be presented and discussed with the directors before a final decision was reached. Of significance is the acquisition of a property from a former staff member for the opening of a new branch warehouse. The acquisition process was hurried and exceeded the capital expenditure provisions for the period. Mr. Johnson’s team viewed the acquisition as a potential fraud on the company, while APS aligned with the director of finance, who considered it a normal transaction.

At the board meeting to discuss the financial statements, members were divided between the two audit firms’ views, leading the chairman to reschedule the meeting. He requested additional information on both parties’ positions and asked them to harmonize their views before the next meeting the following day.

Required:

a. Evaluate the justification or otherwise of an entity having joint auditors. (8 Marks)

b. Following the concerns of Johnson, Odewole, Thomas & Co., present the options available to the firm. (5 Marks)

c. Discuss the points on which the Chairman needs to base his decision, according to standard acquisition procedures. (7 Marks)

d. If the Chairman agrees with the position of Johnson, Odewole, Thomas & Co., determine the reporting requirement and draft an appropriate report for inclusion in the auditors’ report. (6 Marks)

e. Discuss the composition of items that could be marked “For Partner’s Attention” during the conclusion of an audit process. (4 Marks)

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