Question Tag: Debt-equity ratio

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  • 20 Marks

FRPA – APRIL 2024 – L3 – Q4 – Potco PLC Ratios and Performance Report

Compute six ratios for Potco PLC and write a report assessing its financial performance and position relative to the industry.

Potco PLC is a listed Ghanaian company that produces textile prints for both local and African markets. As at the year ended 31 March 2023, the company made a Gross Profit of GH$12,150. Cost of Sales for the year was GH$77,850 and Operating Profit Before Interest and Tax was GH$47,130. Finance Cost for the year was GH$920 and Tax Charged to Profit or Loss was GH$1,400.

The Inventory Turnover was 3.6 times. Dividend Paid Per Share was GH$0. 36 resulting in a Dividend Yield of 6 %. Current Assets consist of Inventory, Cash and Trade Receivables.

Extracts from the Statement of Financial Position as at 31 March 2023 were as follows: GH$

| Non-Current Assets | 63,320 | | Current Asset (excluding Inventory and Cash) | 18,605 | | Current Liabilities | 27,600 | | Shareholder’s Fund | 58,480 | | Cash | 6,000 | | 10% Debenture | 23,500 | | Share Capital (@ GH63) | 18,000 |

The following ratios relate to the industry in which Potco Plc belongs to:

| Profit (after Tax) Margin | 4.1% | | Current Ratio | 1.12 | | Return on Capital Employed (ROCE) | 10.0% | | Inventory Turnover | 3.47 | | Receivables Period | 87 days | | Dividend Yield | 5.8% | | EPS Ratio | 12.0 | | Debt/Equity Ratio | 32.6% |

You are required to: a) As far as the above information permits, compute the following ratios for Potco PLC. i. Profit (after Tax) Margin ii. Current Ratio iii. Return on Capital Employed (ROCE) iv. Receivables Period v. Price/Earnings Ratio vi. Debt/Equity Ratio (12 marks) b) Using the ratios above, write a report to the Board of Potco PLC to assess the Financial Performance and Financial Position of the entity, relative to its industry. (8 marks) [Total: 20 marks]

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  • 15 Marks

FM – Nov 2021 – L3 – Q7 – Financing Decisions and Capital Markets

Analyze the effects of a 1-for-5 rights issue for James Obasi plc, calculate theoretical ex-rights price, and assess investor options and impacts.

James Obasi plc, a medium-sized drone manufacturing firm, is considering a 1-for-5 rights issue at a 15% discount to the current market price of N4.00 per share. Expected issue costs are N2 million, payable from the funds raised. The proceeds from the rights issue will be used to redeem some of the company’s existing bonds at par.

Financial Information:

Statement of Financial Position (N’000):

Required:

a. Ignoring issue costs and any use of the funds raised by the rights issue, calculate: i. The theoretical ex-rights price per share. ii. The value of rights per existing share. (4 Marks)

b. Identify the alternative actions available to an owner of 1,500 shares in James Obasi plc concerning the rights issue and determine the effect of each action on the investor’s wealth. (6 Marks)

c. Calculate the current earnings per share and the revised earnings per share if the rights issue funds are used to redeem some of the existing bonds.
(5 Marks)

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  • 30 Marks

FM – Nov 2018 – L3 – Q1 – Financial Strategy Formulation

Appraisal of a diversification project into holiday travel using WACC and associated financial strategy considerations.

Eko Plc. (Eko) is a listed company in the food retailing sector and has large stores in all major cities in the country. Eko’s board is considering diversifying by opening holiday travel shops in all of its stores.

At a recent board meeting, the directors discussed how the holiday travel shops project (the project) should be appraised. The sales director insisted that Eko’s current weighted average cost of capital (WACC) should be used to evaluate the project, as the majority of its operations will still be in food retailing. The finance director disagreed, stating that the existing cost of equity does not account for the systematic risk of new projects and that the company’s overall WACC would change as a result of the project’s acceptance. The board was also concerned about the market’s reaction to its diversification plans. Another board meeting was scheduled, at which Eko’s advisors would be asked to make a presentation on the project.

You work for Eko’s advisors and have been asked to prepare information for the presentation. You have established the following:

Eko intends to raise the capital required for the project in such a way as to leave its existing debt-to-equity ratio (by market value) unchanged following the diversification. Extracts from Eko’s most recent management accounts are shown below:

Statement of financial position as at May 31, 2017

On May 31, 2017, Eko’s ordinary shares had a market value of 276 kobo (ex-div) and an equity beta of 0.60. For the year ended May 31, 2017, the dividend yield was 4.2%, and the earnings per share were 25 kobo. The return on the market is expected to be 8% p.a, and the risk-free rate is 2% p.a.

Eko’s debentures had a market value of N108 (ex-interest) per N100 nominal value on May 31, 2017, and they are redeemable at par on May 31, 2021.

Companies operating solely in the holiday travel industry have an average equity beta of 1.40 and an average debt-to-equity ratio (by market value) of 3:5. It is estimated that if the project goes ahead, the overall equity beta of Eko will be made up of 90% food retailing and 10% holiday travel shops.

Assume that the income tax rate will be 20% p.a. for the foreseeable future.

Required:

a. Ignoring the project, calculate the current WACC of Eko using:
i. The Capital Asset Pricing Model (CAPM) (8 Marks)
ii. The Gordon Growth Model (6 Marks)

b. Use the CAPM to calculate the cost of equity that should be included in a WACC suitable for appraising the project and explain your reason. (5 Marks)

c. By calculating an overall equity beta and using the CAPM, estimate the overall WACC of Eko assuming that the project goes ahead and comment on the implications of a permanent change in the overall WACC. (5 Marks)

d. Advise whether Eko should diversify its operations and how the stock market might react to the proposed project. (3 Marks)

e. Identify the appropriate project appraisal methodology that should be used when a project’s financing results in a major increase in a company’s market gearing ratio, and using the data relating to Eko, calculate the project discount rate that should be used in this circumstance. (3 Marks)

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  • 20 Marks

PM – Nov 2014 – L2 – Q3 – Divisional Performance Measurement

Compare financial performance of Purity Nigeria Ltd. and Benchmark Co. Ltd using key financial ratios and offer strategic improvement recommendations.

Purity Nigeria Limited is a company that produces table water. The company’s board
plans to restructure its operations with the aim of boosting its market share and
profitability.

The financial results of Purity Nigeria Limited and Bench Mark Co. Limited, which is
the leader in the industry, are as follows:

Operating Statements for the year ended 31 December, 2013

Summarised Statements of Financial Position as at 31 December, 2013.

Required:

a. Compute the following performance indices for both companies:
i Profit margin
ii. Asset turnover
iii. Returns On Capital Employed (ROCE)
iv. Current ratio
v. Debt-equity ratio (5 Marks)

b. Compare and analyse the performance of the two companies computed in (a)
above and explain what the board of Purity Nigeria Limited needs to do to
achieve their objectives. (10 Marks)

c. What other non-financial measures can influence the decision of the board of
Purity Nigeria Limited? (5 Marks)

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  • 20 Marks

FR – Aug 2022 – L2 – Q4 – Financial Statement Analysis

Calculate various financial ratios for Pat Plc and compare them to industry averages and Write a report to assess the financial performance and position of Pat Plc relative to industry standards based on the calculated ratios.

Pat Plc is a listed Ghanaian company that produces textile prints for local and African markets. During the year ended 31 March 2022, the following financial information was available:

Gross profit: GH¢12,150
Cost of sales: GH¢77,850
Operating profit before interest and tax: GH¢7,130
Finance cost: GH¢920
Tax charged to profit or loss: GH¢1,400
Inventory turnover: 3.6 times
Dividend per share: GH¢0.36
Dividend yield: 6%

Extracts from the Statement of Financial Position as at 31 March 2022:

Required:
a. Based on the information provided, compute the following ratios for Pat Plc:
i) Profit (after tax) margin
ii) Current ratio
iii) Return on Capital Employed (ROCE)
iv) Receivables period
v) Price/Earnings ratio
vi) Debt/Equity ratio

b. Using the ratios computed in Question 4a, write a report to the Board of Directors of Pat Plc assessing the financial performance and financial position of the entity, relative to its industry.

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  • 8 Marks

AT – May 2021 – L3 – Q3c – Business income – Corporate income tax

Explain the tax implications of thin capitalisation and changes in stated capital for Adidas Ltd.

The following is an extract of Adidas Ltd for the 2020 year of assessment with basis period January to December each year:

Description 1 January 2020 (GH¢) 31 December 2020 (GH¢)
Stated Capital 1,000,000 1,200,000
Retained Earnings (2,000,000) (1,100,000)
Revaluation Reserves 10,000 10,000
Equity 990,000 110,000

Additional information:

  • Adidas Ltd is owned 100% by IDAS.
  • The loan taken 5 years ago was GH¢12,000,000 from IDAS.
  • Loan balance as at 1 January 2020 was GH¢2,400,000.
  • Loan balance as at 31 December 2020 was GH¢1,200,000.
  • Interest payable for the 2020 year of assessment stood at GH¢150,000 to IDAS.
  • Foreign exchange loss from the loan repayment for 2020 was GH¢20,000.

Required:
i) Explain the tax implications of the above arrangement.
ii) Explain the tax implication of the movement in the stated capital as shown in the extracts above.

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  • 10 Marks

AT – Aug 2022 – L3 – Q5b – Tax Planning

Advise Wina Ltd on the tax implications of acquiring shares and providing a financial facility to Fatia Ltd in Ghana.

Wina Ltd (Wina) is a company incorporated in the United States of America and also resident
in the United States of America. The Company has been looking for opportunities across Africa
to invest its idle funds in support of shareholders’ decision.
In the latter part of 2021, the management of Wina identified Ghana as a country with huge
potentials for foreign investments. Wina intends to acquire 60% shares in Fatia Ltd (Fatia), a
company resident in Ghana with indigenous ownership but with unimpressive financial
records.When the deal is approved, it would provide a financial facility, the equivalent of
GH¢10,000,000 as a loan with interest at the rate of 22.5% comparable to all other interest
rates.
The equity of Fatia amounts to GH¢500,000 comprising Stated Capital of GH¢250,000,
Retained Earnings of GH¢200,000 and Revaluation Reserves of GH¢50,000.
Required:
Using the format of a memo:
Advise the management of Wina as a final level candidate on the tax implications of this
investment and the credit support that Wina can give without any restriction from the Ghana
Revenue Authority.

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  • 6 Marks

AT – Nov 2020 – L3 – Q3a – International taxation

Tax implications of a loan from a parent company and foreign exchange losses for Mandy Ltd, a subsidiary of Menkay Incorporated.

The following information is relevant to Mandy Ltd (Ghana), a subsidiary of Menkay Incorporated, a company resident in Japan.

Following Mandy Ltd’s operational challenges, a loan of US$1,500,000 was secured from its parent company in 2019 year of assessment.

Additional information relevant to Mandy Ltd’s operations:

Description Amount (GH¢)
Interest on loan paid in 2019 300,000
Foreign exchange loss 105,000
Equity:
Share capital 150,000
Retained earnings 300,000
Total equity 450,000

Exchange rate: 1US$ = GH¢5.73

Required:
Determine the tax implication of the above transaction.

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  • 20 Marks

FRPA – APRIL 2024 – L3 – Q4 – Potco PLC Ratios and Performance Report

Compute six ratios for Potco PLC and write a report assessing its financial performance and position relative to the industry.

Potco PLC is a listed Ghanaian company that produces textile prints for both local and African markets. As at the year ended 31 March 2023, the company made a Gross Profit of GH$12,150. Cost of Sales for the year was GH$77,850 and Operating Profit Before Interest and Tax was GH$47,130. Finance Cost for the year was GH$920 and Tax Charged to Profit or Loss was GH$1,400.

The Inventory Turnover was 3.6 times. Dividend Paid Per Share was GH$0. 36 resulting in a Dividend Yield of 6 %. Current Assets consist of Inventory, Cash and Trade Receivables.

Extracts from the Statement of Financial Position as at 31 March 2023 were as follows: GH$

| Non-Current Assets | 63,320 | | Current Asset (excluding Inventory and Cash) | 18,605 | | Current Liabilities | 27,600 | | Shareholder’s Fund | 58,480 | | Cash | 6,000 | | 10% Debenture | 23,500 | | Share Capital (@ GH63) | 18,000 |

The following ratios relate to the industry in which Potco Plc belongs to:

| Profit (after Tax) Margin | 4.1% | | Current Ratio | 1.12 | | Return on Capital Employed (ROCE) | 10.0% | | Inventory Turnover | 3.47 | | Receivables Period | 87 days | | Dividend Yield | 5.8% | | EPS Ratio | 12.0 | | Debt/Equity Ratio | 32.6% |

You are required to: a) As far as the above information permits, compute the following ratios for Potco PLC. i. Profit (after Tax) Margin ii. Current Ratio iii. Return on Capital Employed (ROCE) iv. Receivables Period v. Price/Earnings Ratio vi. Debt/Equity Ratio (12 marks) b) Using the ratios above, write a report to the Board of Potco PLC to assess the Financial Performance and Financial Position of the entity, relative to its industry. (8 marks) [Total: 20 marks]

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  • 15 Marks

FM – Nov 2021 – L3 – Q7 – Financing Decisions and Capital Markets

Analyze the effects of a 1-for-5 rights issue for James Obasi plc, calculate theoretical ex-rights price, and assess investor options and impacts.

James Obasi plc, a medium-sized drone manufacturing firm, is considering a 1-for-5 rights issue at a 15% discount to the current market price of N4.00 per share. Expected issue costs are N2 million, payable from the funds raised. The proceeds from the rights issue will be used to redeem some of the company’s existing bonds at par.

Financial Information:

Statement of Financial Position (N’000):

Required:

a. Ignoring issue costs and any use of the funds raised by the rights issue, calculate: i. The theoretical ex-rights price per share. ii. The value of rights per existing share. (4 Marks)

b. Identify the alternative actions available to an owner of 1,500 shares in James Obasi plc concerning the rights issue and determine the effect of each action on the investor’s wealth. (6 Marks)

c. Calculate the current earnings per share and the revised earnings per share if the rights issue funds are used to redeem some of the existing bonds.
(5 Marks)

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  • 30 Marks

FM – Nov 2018 – L3 – Q1 – Financial Strategy Formulation

Appraisal of a diversification project into holiday travel using WACC and associated financial strategy considerations.

Eko Plc. (Eko) is a listed company in the food retailing sector and has large stores in all major cities in the country. Eko’s board is considering diversifying by opening holiday travel shops in all of its stores.

At a recent board meeting, the directors discussed how the holiday travel shops project (the project) should be appraised. The sales director insisted that Eko’s current weighted average cost of capital (WACC) should be used to evaluate the project, as the majority of its operations will still be in food retailing. The finance director disagreed, stating that the existing cost of equity does not account for the systematic risk of new projects and that the company’s overall WACC would change as a result of the project’s acceptance. The board was also concerned about the market’s reaction to its diversification plans. Another board meeting was scheduled, at which Eko’s advisors would be asked to make a presentation on the project.

You work for Eko’s advisors and have been asked to prepare information for the presentation. You have established the following:

Eko intends to raise the capital required for the project in such a way as to leave its existing debt-to-equity ratio (by market value) unchanged following the diversification. Extracts from Eko’s most recent management accounts are shown below:

Statement of financial position as at May 31, 2017

On May 31, 2017, Eko’s ordinary shares had a market value of 276 kobo (ex-div) and an equity beta of 0.60. For the year ended May 31, 2017, the dividend yield was 4.2%, and the earnings per share were 25 kobo. The return on the market is expected to be 8% p.a, and the risk-free rate is 2% p.a.

Eko’s debentures had a market value of N108 (ex-interest) per N100 nominal value on May 31, 2017, and they are redeemable at par on May 31, 2021.

Companies operating solely in the holiday travel industry have an average equity beta of 1.40 and an average debt-to-equity ratio (by market value) of 3:5. It is estimated that if the project goes ahead, the overall equity beta of Eko will be made up of 90% food retailing and 10% holiday travel shops.

Assume that the income tax rate will be 20% p.a. for the foreseeable future.

Required:

a. Ignoring the project, calculate the current WACC of Eko using:
i. The Capital Asset Pricing Model (CAPM) (8 Marks)
ii. The Gordon Growth Model (6 Marks)

b. Use the CAPM to calculate the cost of equity that should be included in a WACC suitable for appraising the project and explain your reason. (5 Marks)

c. By calculating an overall equity beta and using the CAPM, estimate the overall WACC of Eko assuming that the project goes ahead and comment on the implications of a permanent change in the overall WACC. (5 Marks)

d. Advise whether Eko should diversify its operations and how the stock market might react to the proposed project. (3 Marks)

e. Identify the appropriate project appraisal methodology that should be used when a project’s financing results in a major increase in a company’s market gearing ratio, and using the data relating to Eko, calculate the project discount rate that should be used in this circumstance. (3 Marks)

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  • 20 Marks

PM – Nov 2014 – L2 – Q3 – Divisional Performance Measurement

Compare financial performance of Purity Nigeria Ltd. and Benchmark Co. Ltd using key financial ratios and offer strategic improvement recommendations.

Purity Nigeria Limited is a company that produces table water. The company’s board
plans to restructure its operations with the aim of boosting its market share and
profitability.

The financial results of Purity Nigeria Limited and Bench Mark Co. Limited, which is
the leader in the industry, are as follows:

Operating Statements for the year ended 31 December, 2013

Summarised Statements of Financial Position as at 31 December, 2013.

Required:

a. Compute the following performance indices for both companies:
i Profit margin
ii. Asset turnover
iii. Returns On Capital Employed (ROCE)
iv. Current ratio
v. Debt-equity ratio (5 Marks)

b. Compare and analyse the performance of the two companies computed in (a)
above and explain what the board of Purity Nigeria Limited needs to do to
achieve their objectives. (10 Marks)

c. What other non-financial measures can influence the decision of the board of
Purity Nigeria Limited? (5 Marks)

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  • 20 Marks

FR – Aug 2022 – L2 – Q4 – Financial Statement Analysis

Calculate various financial ratios for Pat Plc and compare them to industry averages and Write a report to assess the financial performance and position of Pat Plc relative to industry standards based on the calculated ratios.

Pat Plc is a listed Ghanaian company that produces textile prints for local and African markets. During the year ended 31 March 2022, the following financial information was available:

Gross profit: GH¢12,150
Cost of sales: GH¢77,850
Operating profit before interest and tax: GH¢7,130
Finance cost: GH¢920
Tax charged to profit or loss: GH¢1,400
Inventory turnover: 3.6 times
Dividend per share: GH¢0.36
Dividend yield: 6%

Extracts from the Statement of Financial Position as at 31 March 2022:

Required:
a. Based on the information provided, compute the following ratios for Pat Plc:
i) Profit (after tax) margin
ii) Current ratio
iii) Return on Capital Employed (ROCE)
iv) Receivables period
v) Price/Earnings ratio
vi) Debt/Equity ratio

b. Using the ratios computed in Question 4a, write a report to the Board of Directors of Pat Plc assessing the financial performance and financial position of the entity, relative to its industry.

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  • 8 Marks

AT – May 2021 – L3 – Q3c – Business income – Corporate income tax

Explain the tax implications of thin capitalisation and changes in stated capital for Adidas Ltd.

The following is an extract of Adidas Ltd for the 2020 year of assessment with basis period January to December each year:

Description 1 January 2020 (GH¢) 31 December 2020 (GH¢)
Stated Capital 1,000,000 1,200,000
Retained Earnings (2,000,000) (1,100,000)
Revaluation Reserves 10,000 10,000
Equity 990,000 110,000

Additional information:

  • Adidas Ltd is owned 100% by IDAS.
  • The loan taken 5 years ago was GH¢12,000,000 from IDAS.
  • Loan balance as at 1 January 2020 was GH¢2,400,000.
  • Loan balance as at 31 December 2020 was GH¢1,200,000.
  • Interest payable for the 2020 year of assessment stood at GH¢150,000 to IDAS.
  • Foreign exchange loss from the loan repayment for 2020 was GH¢20,000.

Required:
i) Explain the tax implications of the above arrangement.
ii) Explain the tax implication of the movement in the stated capital as shown in the extracts above.

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  • 10 Marks

AT – Aug 2022 – L3 – Q5b – Tax Planning

Advise Wina Ltd on the tax implications of acquiring shares and providing a financial facility to Fatia Ltd in Ghana.

Wina Ltd (Wina) is a company incorporated in the United States of America and also resident
in the United States of America. The Company has been looking for opportunities across Africa
to invest its idle funds in support of shareholders’ decision.
In the latter part of 2021, the management of Wina identified Ghana as a country with huge
potentials for foreign investments. Wina intends to acquire 60% shares in Fatia Ltd (Fatia), a
company resident in Ghana with indigenous ownership but with unimpressive financial
records.When the deal is approved, it would provide a financial facility, the equivalent of
GH¢10,000,000 as a loan with interest at the rate of 22.5% comparable to all other interest
rates.
The equity of Fatia amounts to GH¢500,000 comprising Stated Capital of GH¢250,000,
Retained Earnings of GH¢200,000 and Revaluation Reserves of GH¢50,000.
Required:
Using the format of a memo:
Advise the management of Wina as a final level candidate on the tax implications of this
investment and the credit support that Wina can give without any restriction from the Ghana
Revenue Authority.

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  • 6 Marks

AT – Nov 2020 – L3 – Q3a – International taxation

Tax implications of a loan from a parent company and foreign exchange losses for Mandy Ltd, a subsidiary of Menkay Incorporated.

The following information is relevant to Mandy Ltd (Ghana), a subsidiary of Menkay Incorporated, a company resident in Japan.

Following Mandy Ltd’s operational challenges, a loan of US$1,500,000 was secured from its parent company in 2019 year of assessment.

Additional information relevant to Mandy Ltd’s operations:

Description Amount (GH¢)
Interest on loan paid in 2019 300,000
Foreign exchange loss 105,000
Equity:
Share capital 150,000
Retained earnings 300,000
Total equity 450,000

Exchange rate: 1US$ = GH¢5.73

Required:
Determine the tax implication of the above transaction.

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