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  • 8 Marks

FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

The expected return on the market portfolio (estimated from past data) is 12% p.a. with a standard deviation of 15% and the risk-free rate of 4% p.a. The actual prices, last year dividends, and the covariances from three securities (A, B, C) with the market are given in the table below:

Security Actual Price (N) Last Year Dividend (N) Covariance with Market
A 107 1.30 0.025650
B 618 18.00 0.018675
C 1,350 22.00 0.029025

You are required to:

i.

Calculate the betas and the required rates of return of securities A, B, and C. (3 Marks)

ii.

In the table below, you have the market consensus forecast of 12-month price targets, ex-dividends, and the expected dividend growth rate of the securities.

Security 12-month price target (N) Dividend growth rate (%)
A 122.50 12
B 740.00 10
C 1,500.00 11

Assuming the dividends are paid in 12 months exactly, compute the required stock price for the 3 stocks and state your conclusion. (4 Marks)

iii.

Considering the results in (ii) above, explain briefly what will be your strategy? (1 Mark)

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  • 15 Marks

FM – Nov 2017 – L3 – Q7 – Portfolio Management

Evaluate investment risk in different portfolio scenarios and explain the implications of beta and alpha values for KT Plc’s equity.

a. In the context of the selection and holding of investments, discuss each of the following scenarios:

i. An investor holding only one security needs to be concerned with the unsystematic risk of that security. (3 Marks)

ii. However, an investor who holds a number of securities should take account of total risk. (3 Marks)

iii. An investor should never add to a portfolio an investment that yields a return less than the market rate of return. (3 Marks)

b. The equity beta of KT Plc. is 1.2 and the equity alpha is 1.4. Explain the meaning and significance of these values to the company. (6 Marks)

(Total 15 Marks)

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  • 8 Marks

AFM – May 2017 – L3 – Q2b – Sources of finance and cost of capital

Calculate the cost of capital for Oheneba Limited with two different capital structures.

Oheneba Limited is considering the acquisition of a concession in the Brong Ahafo region to enable it to start a quarry business. The average industry beta is 1.6 with an equity-to-debt ratio of 2:1.

The following information was extracted from the books of Oheneba Limited:

Income Statement

You are also informed that the long-term debt of the company is considered risk-free with a gross redemption yield of 10% and the beta coefficient of the company’s equity is 1.2, while the average return on the stock market is 15%.

Required:
i) Determine the cost of capital to apply for the appraisal of the quarry if Oheneba Limited will maintain its capital structure after the implementation of the quarry project. (5 marks)
ii) Determine the cost of capital to apply if the company will change its capital structure to 20% debt and 80% equity. (3 marks)

 

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  • 20 Marks

FM – MAY 2016 – L2 – Q4 – Capital structure | Cost of capital

Discuss the reasons for pecking order in financing, factors influencing capital structure, and calculate the appropriate cost of capital for Pusher Mining Ltd’s new project.

a) The Directors of Moore Plastics Ltd have been deliberating on the company’s capital structure with a view to identifying an optimal financing mix. Opening the deliberation, the Board Chair remarked, “For the past 10 years, we have deployed a financing strategy of reinvesting as much profit as available. When profit is inadequate, we go for borrowing. New equity offers have been a last resort.”

Required:
i) Explain with THREE reasons why most managers tend to use financing strategies that follow the pecking order. (6 marks)
ii) Identify and explain TWO factors the directors of Moore Plastics Ltd should consider in redesigning the company’s capital structure. (4 marks)

b) Pusher Mining Ltd, a large listed company, operates five mineral concessions in Ghana and Ivory Coast. The company’s financial performance for the past five years has been impressive. The company’s recently published financial results indicate that it earned after-tax profit of GH¢250 million and paid dividends of GH¢50 million out of that profit.

Reserves at two of the five mineral concessions will be exhausted in two years’ time, and stakeholders fear this will adversely affect the company’s profitability. Nevertheless, the directors are aiming at maintaining the company’s dividend payment record. To achieve this, they want to pursue a new project in the oil industry to provide additional cash flows. Though the new project will be financed with existing equity and long-term debts, the directors are not sure what cost of capital to use in appraising the new project.

A summary of the company’s financial position before the new oil project follows:

Item GH¢m
Noncurrent assets 620
Current assets 425
Total assets 1,045
Equity
Stated capital 180
Income surplus 685
Shareholders’ fund 865
Liabilities
Current liabilities 20
Bank loans 40
Bonds 120
Total liabilities 180
Total equity and liabilities 1,045

Notes:

  1. Stated capital: Pusher has in issue 40 million ordinary shares of no par value, all of which are listed on the stock exchange. The current market value of the ordinary stock is GH¢5.5 per share. It is estimated that the market value of the ordinary stock will increase by 8% per annum. The equity beta is 1.25.
  2. Bank loans: These are fixed-rate loans from banks in Ghana. The after-tax cost of the loans is 14.5%.
  3. Bonds: These are 16% coupon bonds with a face value of GH¢100 each. The bonds are currently trading at GH¢98.1 each. In 10 years’ time, the bonds may be either converted into 10 ordinary shares or redeemed at face value at the choice of bondholders. Bondholders are assumed to be rational investors.

If the new oil project is implemented, Pusher Mining Ltd’s main competitor in the oil industry would be Cargo Oil Ltd. The estimated equity beta of the competitor is 1.80 and the market value of its equity stock is GH¢150 million. The long-term debt stock of the competitor is valued at GH¢100 million. The systematic risk of debt stocks is assumed to be zero. The risk-free return is 14% and the market return is 20%. The corporate tax rate is 25%.

Required:
Estimate the appropriate cost of capital Pusher Mining Ltd should use in appraising the new project in the oil industry. Show all relevant computations. (10 marks)

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  • 3 Marks

FM – Nov 2017 – L2 – Q5b – Portfolio theory and the capital asset pricing model (CAPM)

Explain the differences between standard deviation and beta and when each is an appropriate measure of risk in a portfolio.

Explain the differences between standard deviation and beta and when each is an appropriate measure of risk in a portfolio. (3 marks)

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  • 14 Marks

FM – MAY 2019 – L2 – Q2a – Capital structure

Calculate the current market capitalization of M&E Ltd and the Weighted Average Cost of Capital (WACC) prior to financing a new project.

Question:
M&E Ltd, recognized as the leader in steel manufacturing, has received an invitation to supply steel for the construction of rail lines to connect the ECOWAS countries, starting from Nigeria. The contract will be for 10 years, and management is considering appraising the investment to enable them to present their proposals for the contract. The following information was extracted from the recently published accounts of M&E Ltd:

GH¢ ‘000
Equity Shares (1,000,000 shares) 70,000
15% Preference shares 50,000
10% (Bonds irredeemable) 30,000
Total 150,000

The Treasury unit of M&E Ltd has estimated that it will require GH¢ 10 million to finance the new project. The total amount would be raised through 10% Irredeemable bonds at the current market price. The cost of Preference shares and Bonds will not change, but equity shareholders will demand an increase of 20% on the current cost of equity.

M&E Ltd has a beta of 0.8, the market risk premium for the steel industry is 6.25%, and the Government of Ghana Bond rate is 20%. The current market price for Irredeemable Bonds of GH¢1,000 nominal value is GH¢850.

M&E Ltd’s dividend policy is to pay constant dividends, and this policy will not change in the foreseeable future. The recent dividend paid was GH¢20 per share. M&E Ltd is a Free Zones Company and therefore pays tax at a rate of 8%.

Required:

i) Calculate the current market capitalization of M&E Ltd. (5 marks)

ii) Calculate the Weighted Average Cost of Capital (WACC) prior to the consideration of the finance for the proposed project. (9 marks)

(Total: 14 marks)

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  • 8 Marks

FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

The expected return on the market portfolio (estimated from past data) is 12% p.a. with a standard deviation of 15% and the risk-free rate of 4% p.a. The actual prices, last year dividends, and the covariances from three securities (A, B, C) with the market are given in the table below:

Security Actual Price (N) Last Year Dividend (N) Covariance with Market
A 107 1.30 0.025650
B 618 18.00 0.018675
C 1,350 22.00 0.029025

You are required to:

i.

Calculate the betas and the required rates of return of securities A, B, and C. (3 Marks)

ii.

In the table below, you have the market consensus forecast of 12-month price targets, ex-dividends, and the expected dividend growth rate of the securities.

Security 12-month price target (N) Dividend growth rate (%)
A 122.50 12
B 740.00 10
C 1,500.00 11

Assuming the dividends are paid in 12 months exactly, compute the required stock price for the 3 stocks and state your conclusion. (4 Marks)

iii.

Considering the results in (ii) above, explain briefly what will be your strategy? (1 Mark)

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  • 15 Marks

FM – Nov 2017 – L3 – Q7 – Portfolio Management

Evaluate investment risk in different portfolio scenarios and explain the implications of beta and alpha values for KT Plc’s equity.

a. In the context of the selection and holding of investments, discuss each of the following scenarios:

i. An investor holding only one security needs to be concerned with the unsystematic risk of that security. (3 Marks)

ii. However, an investor who holds a number of securities should take account of total risk. (3 Marks)

iii. An investor should never add to a portfolio an investment that yields a return less than the market rate of return. (3 Marks)

b. The equity beta of KT Plc. is 1.2 and the equity alpha is 1.4. Explain the meaning and significance of these values to the company. (6 Marks)

(Total 15 Marks)

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  • 8 Marks

AFM – May 2017 – L3 – Q2b – Sources of finance and cost of capital

Calculate the cost of capital for Oheneba Limited with two different capital structures.

Oheneba Limited is considering the acquisition of a concession in the Brong Ahafo region to enable it to start a quarry business. The average industry beta is 1.6 with an equity-to-debt ratio of 2:1.

The following information was extracted from the books of Oheneba Limited:

Income Statement

You are also informed that the long-term debt of the company is considered risk-free with a gross redemption yield of 10% and the beta coefficient of the company’s equity is 1.2, while the average return on the stock market is 15%.

Required:
i) Determine the cost of capital to apply for the appraisal of the quarry if Oheneba Limited will maintain its capital structure after the implementation of the quarry project. (5 marks)
ii) Determine the cost of capital to apply if the company will change its capital structure to 20% debt and 80% equity. (3 marks)

 

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  • 20 Marks

FM – MAY 2016 – L2 – Q4 – Capital structure | Cost of capital

Discuss the reasons for pecking order in financing, factors influencing capital structure, and calculate the appropriate cost of capital for Pusher Mining Ltd’s new project.

a) The Directors of Moore Plastics Ltd have been deliberating on the company’s capital structure with a view to identifying an optimal financing mix. Opening the deliberation, the Board Chair remarked, “For the past 10 years, we have deployed a financing strategy of reinvesting as much profit as available. When profit is inadequate, we go for borrowing. New equity offers have been a last resort.”

Required:
i) Explain with THREE reasons why most managers tend to use financing strategies that follow the pecking order. (6 marks)
ii) Identify and explain TWO factors the directors of Moore Plastics Ltd should consider in redesigning the company’s capital structure. (4 marks)

b) Pusher Mining Ltd, a large listed company, operates five mineral concessions in Ghana and Ivory Coast. The company’s financial performance for the past five years has been impressive. The company’s recently published financial results indicate that it earned after-tax profit of GH¢250 million and paid dividends of GH¢50 million out of that profit.

Reserves at two of the five mineral concessions will be exhausted in two years’ time, and stakeholders fear this will adversely affect the company’s profitability. Nevertheless, the directors are aiming at maintaining the company’s dividend payment record. To achieve this, they want to pursue a new project in the oil industry to provide additional cash flows. Though the new project will be financed with existing equity and long-term debts, the directors are not sure what cost of capital to use in appraising the new project.

A summary of the company’s financial position before the new oil project follows:

Item GH¢m
Noncurrent assets 620
Current assets 425
Total assets 1,045
Equity
Stated capital 180
Income surplus 685
Shareholders’ fund 865
Liabilities
Current liabilities 20
Bank loans 40
Bonds 120
Total liabilities 180
Total equity and liabilities 1,045

Notes:

  1. Stated capital: Pusher has in issue 40 million ordinary shares of no par value, all of which are listed on the stock exchange. The current market value of the ordinary stock is GH¢5.5 per share. It is estimated that the market value of the ordinary stock will increase by 8% per annum. The equity beta is 1.25.
  2. Bank loans: These are fixed-rate loans from banks in Ghana. The after-tax cost of the loans is 14.5%.
  3. Bonds: These are 16% coupon bonds with a face value of GH¢100 each. The bonds are currently trading at GH¢98.1 each. In 10 years’ time, the bonds may be either converted into 10 ordinary shares or redeemed at face value at the choice of bondholders. Bondholders are assumed to be rational investors.

If the new oil project is implemented, Pusher Mining Ltd’s main competitor in the oil industry would be Cargo Oil Ltd. The estimated equity beta of the competitor is 1.80 and the market value of its equity stock is GH¢150 million. The long-term debt stock of the competitor is valued at GH¢100 million. The systematic risk of debt stocks is assumed to be zero. The risk-free return is 14% and the market return is 20%. The corporate tax rate is 25%.

Required:
Estimate the appropriate cost of capital Pusher Mining Ltd should use in appraising the new project in the oil industry. Show all relevant computations. (10 marks)

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  • 3 Marks

FM – Nov 2017 – L2 – Q5b – Portfolio theory and the capital asset pricing model (CAPM)

Explain the differences between standard deviation and beta and when each is an appropriate measure of risk in a portfolio.

Explain the differences between standard deviation and beta and when each is an appropriate measure of risk in a portfolio. (3 marks)

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  • 14 Marks

FM – MAY 2019 – L2 – Q2a – Capital structure

Calculate the current market capitalization of M&E Ltd and the Weighted Average Cost of Capital (WACC) prior to financing a new project.

Question:
M&E Ltd, recognized as the leader in steel manufacturing, has received an invitation to supply steel for the construction of rail lines to connect the ECOWAS countries, starting from Nigeria. The contract will be for 10 years, and management is considering appraising the investment to enable them to present their proposals for the contract. The following information was extracted from the recently published accounts of M&E Ltd:

GH¢ ‘000
Equity Shares (1,000,000 shares) 70,000
15% Preference shares 50,000
10% (Bonds irredeemable) 30,000
Total 150,000

The Treasury unit of M&E Ltd has estimated that it will require GH¢ 10 million to finance the new project. The total amount would be raised through 10% Irredeemable bonds at the current market price. The cost of Preference shares and Bonds will not change, but equity shareholders will demand an increase of 20% on the current cost of equity.

M&E Ltd has a beta of 0.8, the market risk premium for the steel industry is 6.25%, and the Government of Ghana Bond rate is 20%. The current market price for Irredeemable Bonds of GH¢1,000 nominal value is GH¢850.

M&E Ltd’s dividend policy is to pay constant dividends, and this policy will not change in the foreseeable future. The recent dividend paid was GH¢20 per share. M&E Ltd is a Free Zones Company and therefore pays tax at a rate of 8%.

Required:

i) Calculate the current market capitalization of M&E Ltd. (5 marks)

ii) Calculate the Weighted Average Cost of Capital (WACC) prior to the consideration of the finance for the proposed project. (9 marks)

(Total: 14 marks)

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