Question Tag: WACC

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  • 30 Marks

FM – May 2019 – L3 – Q1 – Mergers and Acquisitions

Evaluate the synergy expected from a proposed merger between Pako Plc. and RT Plc. using free cash flow analysis, and discuss limitations and alternatives.

Pako Plc. will soon announce a take-over bid for Ronke Tina (RT) Plc., a company in the same industry. The initial bid will be an all-share bid of four Pako shares for every five RT Plc. shares. The most recent annual data relating to the two companies are shown below:

The take-over is expected to result in cost saving in advertising and distribution, reducing the operating costs (including depreciation) of Pako from 76% of sales to 70% of sales. The growth rate of the combined company is expected to be 6% per year for four years and 5% per year thereafter. RT’s debt obligations will be taken over by Pako. The corporate tax rate is expected to remain at 30%.

Sales and costs relevant to the decision may be assumed to be in cash terms.

Required:

a. Estimate how much synergy is expected to be created from the take-over, using free cash flow to the firm analysis for each individual company and the potential combined company. State clearly any assumptions that you make.
Note: The weighted average cost of capital of the combined company is assumed to be 9%. (20 Marks)

b. Discuss any five limitations of the above estimates. (5 Marks)

c. Explain, generally, three advantages and two disadvantages of expansion through merger and acquisition rather than through organic growth. (5 Marks)
(Total: 30 Marks)

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  • 30 Marks

FM – Nov 2014 – L3 – SA – Q1 – Investment Appraisal Techniques

Evaluate the financial feasibility of a cement production project using cost of capital, NPV, and MIRR methods.

AK Plc is a company listed on the Nigerian Stock Exchange. It is involved in property development and sales.

The company currently imports more than 60% of its cement requirements. At a recent meeting of the board of directors, a decision was taken to establish a division for the production of cement in Ore, Ondo State. If the division is set up and the cement production goes ahead, output from the division will be sold to AK Plc and external customers at market price. For planning purposes, it has been decided that the financial viability of the project over the next five years should be determined.

The sum of N2 billion will be required. The sum of N500 million will be spent to acquire an existing factory considered suitable for the project. The balance of N1.5 billion will be applied for the procurement and installation of essential plant and equipment. Tax allowance can be claimed on plant and equipment at a uniform amount over 5 years with NIL scrap value.

A total of N20 million has been spent on various surveys (market, technical, financial, etc.) to date out of which N10 million has been paid. The balance of N10 million is due for payment at the end of year 1.

Production of cement for the next five years is projected as follows:

Year Bags
1 500,000
2 600,000
3 650,000
4 800,000
5 700,000

A bag of cement sells currently for N2,000 in the open market. This price is expected to increase at the rate of 5% per annum. Variable cost is now N1,000 per bag. This will increase at 4% per annum. Fixed overhead costs will be N50 million at current prices but will rise by 8% per annum. Apportioned head office charges of N25 million at current prices will rise by 10% per annum. Fifty per cent (50%) of the total initial outlay of N2 billion is to be funded with a loan from a Federal Government Development Bank at a concessionary fixed interest rate of 8%, payable at the end of each year. Half of the loan will be repaid at the end of year 3 while the balance will be paid at the end of year 5. The project will require a working capital of 10% of annual revenue, and this should be available at the beginning of each year.

The company uses a current Weighted Average Cost of Capital (WACC) of 11% to appraise all capital projects. The asset beta of the company is 1.2, equity beta is 1.6, risk-free rate is 5%, while the market risk premium is 7%.

The Finance Director is of the view that it is not appropriate to use the existing WACC to appraise the new project. He has identified a listed company that currently produces cement and packaged fruit drinks. The company has the following financial statistics:

  • Equity beta: 1.82
  • Debt beta: 0.4
  • Debt/Equity ratio: 40%
  • 60% of the market value of the company is attributed to cement production, while 40% of the value is attributed to the fruit drinks division.
  • The fruit drinks division has an equity beta of 0.8.

The new project is expected to move AK Plc to the target Debt/Equity ratio of 30%. Tax rate is 25% for the two companies and is paid in the year profit is made.

Required:

a. Compute the appropriate cost of capital that AK Plc should use to appraise the cement project and state why you consider this rate more appropriate than the existing WACC of 11%.

  • Note: Your final cost of capital should be rounded up to the nearest whole number. State any assumptions made. (12 Marks)

b. Compute the Net Present Value (NPV) and Modified Internal Rate of Return (MIRR) of the project, assuming a cost of capital of 13%.

  • (Work to the nearest N million). (16 Marks)

c. Recommend whether the project should be accepted or not, using both NPV and MIRR methods. (2 Marks)

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  • 15 Marks

FM – May 2022 – L3 – Q5 – Cost of Capital

Calculate market value WACC for JP and discuss its preference over book value WACC for investment appraisals.

The directors of Jindadi Plc. (JP), an Abuja-based entertainment company, are currently considering the appropriate cost of capital to use in appraising capital investments. It is the policy of the company to assess the financial viability of all capital projects using the net present value criterion.

You have been provided with some financial information about the company.

JP has an equity beta of 1.2, and the ex-dividend market value of the company’s equity is N1 billion. The ex-interest market value of the convertible bonds is N168 million, and the ex-dividend market value of the preference shares is N50 million.

The convertible bonds of JP have a conversion ratio of 19 ordinary shares per bond. The conversion date and redemption date are both on the same date in five years’ time. The current ordinary share price of JP is expected to increase by 4% per year for the foreseeable future.

The equity risk premium is 5% per year, and the risk-free rate of return is 4% per year. JP pays profit tax at an annual rate of 30% per year.

Required:

a. Calculate the market value after-tax weighted average cost of capital of JP, explaining clearly any assumptions you make. (10 Marks)

b. Discuss why market value weighted average cost of capital is preferred to book value weighted average cost of capital when making investment decisions. (5 Marks)

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  • 30 Marks

FM – May 2018 – L3 – SA – Q1 – Investment Appraisal Techniques

Evaluate the NPV of Plateau Plc.'s project, assess sensitivity, discuss political risk, and explore real options for the project.

Plateau Plc. (PT) is a Nigerian company that manufactures and sells innovative products. Following favourable market research that cost N4,000,000, PT has developed a new product. It plans to set up a production facility in Kano, although its board had contemplated setting up the facility in an overseas country. The project will have a life of four years.

The selling price of the new product will be N5,900 per unit, with sales in the first year to December 31, 2019, expected to be 120,000 units, increasing by 5% per annum thereafter. Relevant direct labour and material costs are expected to be N3,400 per unit, and incremental fixed production costs are expected to be N60 million per annum. The selling price and costs are stated in December 31, 2018 prices and are expected to increase at a rate of 3% per annum. Research and development costs to December 31 will amount to N25 million.

Investment in working capital will be N30 million on December 31, 2018, and this will increase in line with sales volumes and inflation. Working capital will be fully recoverable on December 31, 2022.

The company will need to rent a factory during the life of the project. Annual rent of N20 million will be payable in advance on December 31 each year and will not increase over the life of the project.

Plant and machinery will cost N1 billion on December 31, 2018. The plant and machinery are expected to have a resale value of N300 million (at December 31, 2022, prices) at the end of the project. The plant and machinery will attract 20% (reducing balance) capital allowances in the year of expenditure and in every subsequent year of ownership by the company, except in the final year when there will be a balancing allowance or charge.

Assume a corporate tax rate of 20% per annum in the foreseeable future and that tax flows arise in the same year as the cash flows which gave rise to them.

The directors are concerned by rumours in the industry of research by a rival company into a much cheaper alternative product. However, the rumours suggest that this research will take another year to complete, and if successful, it will take a further year before the alternative product comes on the market.

An appropriate weighted average cost of capital for the project is 10% per annum.

Required:

a. Calculate, using money cash flows, the NPV of the project on December 31, 2018, and advise the company whether to proceed with the project or not.
(15 Marks)

b. Calculate and interpret the sensitivity of the project to a change in:

  • (i) The annual rent of the factory (2 Marks)
  • (ii) The weighted average cost of capital (4 Marks)

c. If the board of PT decided to set up the manufacturing facility overseas, advise the board on how political risk could change the value of the project and how it might limit its effects. (4 Marks)

d. Discuss briefly FOUR real options available to PT in relation to the new project. (5 Marks)

(Total 30 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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  • 6 Marks

CR – May 2021 – L3 – Q2a(i) – Impairment of Assets and CGU Valuation

Evaluate the acceptability of accounting practices used for CGU impairment test, focusing on discount rates and foreign exchange issues under IAS 36.

  • Gyamfi Ltd (Gyamfi) is an international company with a presence in Ghana, providing spare parts for the automotive industry. It operates in various jurisdictions, each with different currencies. In 2020, Gyamfi faced financial difficulties partly due to the COVID-19 pandemic, resulting in a decline in revenue, a reorganization, and restructuring of the business. As a result, Gyamfi reported a loss for the year.

    Gyamfi conducted an impairment test for goodwill, but no impairment was recognized. The company applied a single discount rate to all cash flows for all cash-generating units (CGUs), regardless of the currency in which the cash flows were generated. The discount rate used was the weighted average cost of capital (WACC), and Gyamfi used the 10-year government bond rate of its jurisdiction as the risk-free rate in the calculation.

    Additionally, Gyamfi built its impairment model using forecasts denominated in the parent company’s functional currency, arguing that any other approach would be unrealistic and impracticable. Gyamfi claimed that the CGUs had different risk profiles in the short term, but there was no basis for claiming that their risk profiles were different over a longer business cycle.

    Impairment of Non-Current Assets:
    Gyamfi also tested its non-current assets for impairment. A building located overseas was deemed impaired due to flooding in the area. The building was acquired on 1 April 2020 for 25 million dinars when the exchange rate was 2 dinars to the Ghana Cedi. The building is carried at cost. As of 31 March 2021, the building’s recoverable amount was determined to be 17.5 million dinars. The exchange rate on 31 March 2021 was 2.5 dinars to the Ghana Cedi. Buildings are depreciated over 25 years.

    The tax base and carrying amounts of the non-current assets before the impairment write-down were identical. The impairment of the non-current assets is not deductible for tax purposes. No deferred tax adjustment has been made for the impairment. Gyamfi expects to make profits for the foreseeable future and assumes the tax rate is 25%. No other deferred tax effects need to be considered besides the ones relating to the impairment of the non-current assets.

    Requirements (as per question):
    i) Evaluate the acceptability of the accounting practices under IAS 36: Impairment of Assets (6 marks).

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  • 20 Marks

PM – May 2019 – L2 – Q2 – Divisional Performance Measurement

Discuss the benefits of EVA and calculate it for Tees Nigeria Ltd based on provided financial data.

Peter Drucker opined that “until a business returns a profit that is greater than its cost of capital, it operates at a loss.” Therefore, experts have challenged accounting profit as a good measure of business value increase and proposed economic value added (EVA) as a better measure.

Tees Nigeria Limited has presented the following financial data for the year ended 31 December 2018:

Income Statement 2018:

Item ₦000
Profit before interest and tax 75,000
Interest cost (9,000)
Profit before tax 66,000
Tax at 30% (19,800)
Profit after tax 46,200
Dividends paid (30,000)
Retained profit 16,200

Statement of Financial Position 2018:

Item ₦000
Non-current assets 305,000
Net current assets 190,000
Total assets 495,000
Shareholders’ funds 395,000
Long-term debt 100,000
Capital employed 495,000

Notes:
(i) Capital employed at the beginning of the year was ₦420 million.
(ii) The company had non-capitalised leased assets of ₦24 million.
(iii) The estimated cost of equity was 10%, and the cost of debt was 7%.
(iv) The company’s target capital structure is 60% equity and 40% debt.
(v) Other non-cash expenses were ₦16 million.
(vi) Depreciation is equal to economic depreciation.

Required:
a. Discuss the perceived benefits of using EVA to measure business performance. (10 Marks)
b. Calculate the real economic profit of Tees Nigeria Limited using EVA. (10 Marks)

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  • 20 Marks

MA – Mar 2023 – L2 – Q1a – Other aspects of performance measurement

Calculate EVA for Vilagio Engineering for 2021 and 2022 and comment on its performance.

Vilagio Engineering (VE) is a listed company manufacturing pumps and valves for use in the irrigation sector. The CEO has tasked you to assess Vilagio’s performance using Economic Value Added. Below is an extract of their financial statements.

Income Statement extract for the year:

Additional information:
i) Capital employed at the end of 2020 amounted to GH¢350 million.
ii) VE had non-capitalised leases valued at GH¢16 million in each of the years 2020 to 2022. Ignore amortisation calculations.
iii) VE’s pre-tax cost of debt was estimated to be 9% in 2021 and 10% in 2022.
iv) VE’s cost of equity was estimated to be 15% in 2021 and 17% in 2022.
v) The target capital structure is 70% equity, 30% debt.
vi) The rate of taxation is 30% in both 2021 and 2022.
vii) Economic depreciation amounted to GH¢64 million in 2021 and GH¢72 million in 2022. These amounts were equal to the depreciation used for tax purposes and depreciation charged in the income statements.
viii) Interest payable amounted to GH¢6 million in 2021 and GH¢8 million in 2022.
ix) Other non-cash expenses amounted to GH¢20 million per year in both 2021 and 2022.

Required:
a) Estimate the Economic Value Added (EVA) for Vilagio Engineering for both 2021 and 2022, and comment on the company’s performance.
b) State THREE (3) advantages and TWO (2) disadvantages of EVA.
c) Explain the relationship between EVA and Net Present Value (NPV).

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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

AFM – Nov 2017 – L3 – Q2 – Sources of finance and cost of capital

Calculation of the cost of capital using the WACC and CAPM methods for a company and discussing when to use the cost of equity or WACC for discounting.

Animal Farm Product Ltd, (AFP), a manufacturer of veterinary medicines for farm animals, wishes to estimate its current cost of capital.

The following figures have been extracted from their most recent accounts:

Other relevant data:

  • The current market value of AFP’s ordinary shares is GH¢12.50 per share cum-dividend. AFP’s beta is 1.4, the risk-free rate is 3%, and the return on the SEC index (the market proxy) is 8%. An annual dividend of GH¢800,000 is due for payment shortly.
  • The 8% debentures are irredeemable and are trading at a current market value of GH¢106.00, a GH¢6.00 premium over their issue price of GH¢100.00. Semi-annual interest of GH¢4 million has just been paid on the debentures.
  • The 6% preference shares are trading at a current market value of GH¢6.00, a GH¢1 above their issue price of GH¢5.00. Interest has just been paid on these preference shares.
  • There have been no issues or redemptions of ordinary shares or debentures during the past five years, and the corporation tax rate remains at 12.5%. Assume that tax relief on the debenture interest arises at the same time as the interest payment.

Required:

a) Calculate the cost of capital that AFP should use as a discount rate when appraising new marginal investment opportunities. (11 marks)

b) Explain when firms should discount projects using:

  • The cost of equity;
  • The WACC instead; and
  • When should they use neither? You may use the information and your results in part (a) as examples. (6 marks)

c) Discuss what type of covenants might be attached to bonds. (3 marks)

 

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  • 5 Marks

AFM – May 2018 – L3 – Q1c – Theories of capital structure

Calculating the WACC for different financing options and determining the optimal capital structure.

Paisley Brothers Ltd, a company producing loud paisley shirts, has a net operating income of GH¢20,000 and is faced with the following three options for how to structure its debt and equity:

i) Take no debt and pay shareholders a return of 9%.
ii) Borrow GH¢50,000 at 3% and pay shareholders an increased return of 10%.
iii) Borrow GH¢90,000 at 6% and pay a 13% return to shareholders.

Assuming no taxation and a 100% payout ratio:

Required:
Calculate the Weighted Average Cost of Capital (WACC) for each of the options and determine which method is optimal. (5 marks)

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  • 9 Marks

FM – May 2021 – L2 – Q3b – Cost of Capital

Calculate Gbewaa Ghana Ltd’s Weighted Average Cost of Capital

b) Gbewaa Ghana Ltd has issued 10 million shares with a market value of GH¢5 per share. The equity beta of the company is 1.2. The current yield of short-term government debt is 14% per annum, and the equity risk premium is approximately 5% per annum. The debt finance of Gbewaa Ghana Ltd consists of bonds with a book value of GH¢10,000,000. These bonds pay interest at 18% per annum, and the par value and market value of each bond is GH¢100. The company’s tax rate is 25%.

Required:

Calculate Gbewaa Ghana Ltd’s Weighted Average Cost of Capital. (9 marks)

 

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  • 25 Marks

FM – MAY 2016 – L2 – Q2 – Cost of capital

Calculate SAFOO Ltd's WACC and discuss factors influencing the choice of debt finance, as well as the theoretical ex-right price and value of rights.

a) SAFOO Ltd has in issue 5 million shares with a market value of GH¢3.81 per share. The equity beta of the company is 1.2. The yield on short-term government debt is 23% per year, and the equity risk premium is 5% per year. The debt finance of SAFOO Ltd consists of bonds with a total book value of GH¢2 million. These bonds pay annual interest before tax of 25%. The par value and market value of each bond is GH¢100. The company pays tax at 25%.

Required:
Calculate SAFOO Ltd’s Weighted Average Cost of Capital (WACC).
(10 marks)

b) Choosing an appropriate source of business finance can be a difficult and time-consuming task due to the variety of funding options available. Financing can come in the form of debt or investment, and finance terms can vary significantly.

Required:
i) Discuss FOUR factors that a company should consider when choosing a source of debt finance.
(6 marks)

ii) Explain THREE factors that may be considered by providers of finance in deciding how much to lend to a company.
(3 marks)

c) A company with 20 million shares in issue announces a 2 for 5 rights issue at a price of GH¢3 per share. The market price of the existing shares before the rights issue is GH¢3.70.

Required:
i) What is the theoretical ex-right price?
(3 marks)

ii) What is the theoretical value of the rights?
(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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  • 25 Marks

FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal

Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.

a) Okechukwu Ltd is financed by three types of capital:

  • i) 1 million 50p ordinary shares each having a current market value of GH¢5.20 cum div. The current dividend, which is due to be paid shortly, is 20p per share. The dividend has grown steadily in the past at a compound annual rate of 15% and is generally expected to continue doing so indefinitely.
  • ii) 200,000 GH¢1 irredeemable 8% preference shares, each having a current market value of 50p ex div.
  • iii) GH¢2 million 10% debentures, redeemable in 20 years at a price of 110. The current market value is 80 ex int.

Okechukwu is considering a new project having the same risk characteristics as existing projects, which would require an immediate outlay of GH¢150,000 and would produce annual net cash inflow of GH¢30,000 indefinitely.

Required:

Evaluate the viability of the new project using appropriate computations.
(15 marks)

b) Foreign currency risk can be managed to reduce or eliminate the risk. Measures to reduce currency risk are known as hedging.

Required:

i) Explain Transaction and Economic Exposure.
(5 marks)

ii) Explain FIVE ways of mitigating transaction exposure.
(5 marks)

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