FINANCIAL MANAGEMENT – Page 10

FM – L2 – Q33 – Dividend policy

Suggest share price for Kumasi Transport PLC based on 25% dividend payout using dividend growth model.

Question

he directors of an all-equity company are considering the company’s policy on dividends and retentions. The cost of capital is 9% and the company is able to invest in new capital projects that will earn this return. The company’s shares are quoted and traded on a major stock market.

In the year just ended, the earnings per share were GH¢2.00 per share. The company pays a dividend annually, and is about to pay a dividend for the year just ended on the basis of its selected dividend and retentions policy.

Required:

Suggest what the company’s share price might be if the directors select a policy of paying annual dividends that are equal to:

(a) 25% of earnings

(b) 50% of earnings

Answer

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Tags: Dividend Growth Model, Dividend Policy, Earnings retention, Equity financing, Share price valuation
Level: Level 2

Topic: Dividend policy

FM – L2 – Q32 – Sources of finance

Explain key features and appropriate uses of equity, venture capital, business angels, private equity funds, and bonds as sources of finance.

Question

Explain the key features of the sources of finance listed below. Describe when it might be appropriate to use each of them.

(a) Equity (shares)

(b) Venture capital

(d) Private equity fund

(e) Bonds

Answer

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Tags: Bonds, Business angels, Capital structure, Equity, Financing options, Private equity, Venture capital
Level: Level 2

Topic: Sources of finance: equity

FM – L2 – Q31 – Sources of finance: debt

Calculate the change in EPS if convertible bonds are converted into equity shares for a company with given financial data.

Question

A company has the following equity shares and bonds in issue:

2,000,000 equity shares of GH¢0.50 each.

GH¢1,000,000 of 4% convertible bonds.

The current earnings per share (EPS) is GH¢0.25.

The rate of tax is 30%.

The convertible bonds are convertible into equity shares at the rate of 40 shares for every GH¢100 of bonds.

Required

On the basis of this information, calculate the expected change in EPS if all the bonds are converted into equity shares.

Answer

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Tags: Convertible bonds, Corporate finance, Earnings per share, Equity shares, Financial instruments, Taxation
Level: Level 2

Topic: Sources of finance: debt

FM – L2 – Q30 – Financial markets

Outline advantages/disadvantages of stock exchange listing and types of issue costs associated.

Question

(a) Outline the advantages and disadvantages of obtaining a stock exchange listing.

(b) What are the types of issue costs that are associated with obtaining a stock exchange listing?

Answer

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Tags: Advantages, Disadvantages, Equity Finance, issue costs, listing, public quotation, Stock exchange
Level: Level 2

Topic: Financial markets

FM – L2 – Q29 – Sources of finance: equity

Calculate the theoretical ex-rights price per share for Kumasi Lubricants Plc's rights issue to fund new equipment.

Question

Kumasi Lubricants Plc wishes to increase its production capacity by purchasing additional plant and equipment at a cost of GH¢3.8 million. The abridged statement of profit or loss for the year ended 30th November 20X6 is as follows:

	GH¢m
Sales turnover	140.6
Profit before interest and taxation	8.4
Interest	6.8
Profit before tax	1.6
Tax	0.4
Profit after taxation	1.2

Earnings per share: 15 cents

In order to finance the purchase of the new plant and equipment, the directors of the company have decided to make a rights issue equal to the cost of the equipment. The shares are currently quoted on the stock exchange at GH¢2.70 per share and the new shares will be offered to shareholders at GH¢1.90 per share.
Required:
(a) Calculate:
(i) the theoretical ex-rights price per share

(ii) the value of the rights on each existing share

(iii) Existing P/E ratio = GH¢2.70 / GH¢0.15 = 18.0

(b) What are the options available to a shareholder who receives a rights offer from a company?

Answer

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Tags: Equity financing, Rights issue, Shareholder options, Stock market
Level: Level 2

Topic: Sources of finance: equity

FM – L2 – Q28 – Sources of finance: equity

Calculate the theoretical ex-rights price per share for a company's 1 for 4 rights issue to finance new plant and equipment.

Question

A company, Kofi Enterprises Plc, wishes to increase its production capacity by purchasing additional plant and equipment. Its statement of profit or loss for the year ended 30th November Year 3 is as follows:

	GH¢m
Sales revenue	224
Profit before interest and taxation	45.5
Interest	11.4
Profit before tax	34.1
Tax	7.7
Profit after tax	26.4

Earnings per share: GH¢0.30

To finance the new investment, Kofi Enterprises Plc will make a 1 for 4 rights issue. The shares are currently quoted on the Stock Exchange at GH¢5.50 per share and the new shares will be offered to shareholders at GH¢4.50 per share.
Ignore the transaction costs of the share issue.

Required:
(A) Calculate the theoretical ex-rights price per share.

(B) Calculate the value of the rights on each existing share.

Answer

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Tags: Equity financing, Rights issue, Share valuation, Stock exchange, Value of rights
Level: Level 2

Topic: Sources of finance: equity

FM – L2 – Q27a – Portfolio Theory and CAPM

Calculate the average rate of return for two stocks over five years.

Question

Apex Enterprises has a mixture of investment portfolios, Stock A and Stock B. The historical performance return on the stocks are as follows:

Year	Stock A Return	Stock B Return
20X5	-10%	-3%
20X6	18%	21%
20X7	39%	44%
20X8	14%	4%
20X9	33%	28%

Required:
(a) Calculate the average rate of return for each stock during the period of 20X5 to 20X9.

(b) Calculate the average return on the portfolio during the period if Apex Enterprises held 50% each of Stock A and Stock B.

Answer

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Tags: Financial management, Investment Analysis, Portfolio theory, risk analysis, Standard deviation
Level: Level 2

Topic: Portfolio theory and the capital asset pricing model (CAPM)

FM – L2 – Q25 – Portfolio theory and the capital asset pricing model (CAPM)

Calculate expected return and risk for two projects and advise on investment choice based on risk-return tradeoff.

Question

Regal Enterprises Ltd. has a mixture of investment portfolios, Project 3 and Project 4. The historical performance return on the projects are as follows:

	Return	Probability
Project 3	6.0	0.6
	1.0	0.4
Project 4	8.0	0.5
	-1.0	0.5

Required:
(a) Calculate the expected return and standard deviation for Project 3 and Project 4. (6 marks)
(b) The divisional manager will invest in projects that are more risky if they offer a higher return. Advise which project the manager will invest in, considering the expected returns of Project 1 (3.6) and Project 2 (3.95).

Answer

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Tags: CAPM, expected return, Investment decisions, Portfolio theory, risk analysis, Standard deviation
Level: Level 2

Topic: Portfolio theory and the capital asset pricing model (CAPM)

FM – L2 – Q23 – Portfolio theory and CAPM

Calculate mean and standard deviation of expected return for Security X based on economic states.

Question

An investor is planning to invest in two securities, Security X and Security Y. The expected return from each security will depend on the state of the economy, as follows:

State of the economy	Probability	Return from Security X	Return from Security Y
Strong	0.25	15%	20%
Fair	0.60	10%	8%
Weak	0.15	2%	(6%)

Required:
(a) Calculate the mean and standard deviation of the expected return from Security X.

(b) Calculate the mean and standard deviation of the expected return from Security Y.

Cov_x,y = Σ p (x – x̄)(y – ȳ)

(d) Calculate the correlation coefficient for returns from Security X and Security Y, for a portfolio consisting of 50% of the funds invested in Security X and 50% of the funds invested in Security Y. The formula for correlation coefficient is:

ρ_XY = Covariance_XY / (σ_X σ_Y)

where:
σ_x = the standard deviation of returns from Security X
σ_y = the standard deviation of returns from Security Y
Cov_x,y = Covariance of X and Y

Comment on the correlation coefficient.

(e) Calculate expected return, the variance and standard deviation of a portfolio consisting of 50% of the funds invested in Security X and 50% of the funds invested in Security Y. The formula for correlation coefficient is: a²(Variance X)² + (1-a)²(Variance Y)² + 2a(1-a)Cov_x,y

where:
a = the proportion of the portfolio invested in Security X
(1-a) = the proportion of the portfolio invested in Security Y
Variance X = the variance of the returns from Security X
Variance Y = the variance of the returns from Security Y

(f) Calculate expected return, the variance and standard deviation of a portfolio consisting of 80% of the funds invested in Security X and 20% of the funds invested in Security Y.

Answer:

Answer

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Tags: expected return, Portfolio theory, Security X, Security Y, Standard deviation, Variance
Level: Level 2

Topic: Portfolio theory and the capital asset pricing model (CAPM)

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

Question

Tema Electrical Plc is considering whether to purchase a machine for the manufacture of a new product, Product X. It has been estimated that Product X would have a life of four years and at a selling price of GH¢8 per unit, annual sales demand would be 400,000 units in Year 1, 600,000 units in Year 2 and 800,000 in each of Years 3 and 4.

Variable production and selling costs would be GH¢6 per unit. Incremental annual fixed cost expenditures (all cash cost items) would be GH¢500,000 in Year 1, rising by GH¢20,000 each year.

The machine, which has an annual output capacity of 700,000 units of Product X, would cost GH¢1,200,000 and would have a resale value of GH¢200,000 at the end of Year 4. Capital allowances would be available on a 25% annual reducing balance basis, with a balancing charge or allowance in the year of disposal. Tax at 25% is payable one year in arrears of the profits to which it relates.

Tema Electrical Plc is financed 70% by equity capital and 30% by debt capital. The equity has a cost of 10% and the debt has a cost of 8.9% (before tax).

Required

Calculate the net present value of the proposed project and recommend whether the investment in the machine should be undertaken.

Answer

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Tags: capital allowances, Cash Flows, Cost of Capital, Discounted cash flow, Financial management, investment appraisal, NPV, project evaluation, Taxation, WACC
Level: Level 2

Topic: Discounted cash flow

Subject (SQ): FINANCIAL MANAGEMENT

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FM – L2 – Q33 – Dividend policy

Suggest share price for Kumasi Transport PLC based on 25% dividend payout using dividend growth model.

FM – L2 – Q32 – Sources of finance

Explain key features and appropriate uses of equity, venture capital, business angels, private equity funds, and bonds as sources of finance.

FM – L2 – Q31 – Sources of finance: debt

Calculate the change in EPS if convertible bonds are converted into equity shares for a company with given financial data.

FM – L2 – Q30 – Financial markets

Outline advantages/disadvantages of stock exchange listing and types of issue costs associated.

FM – L2 – Q29 – Sources of finance: equity

Calculate the theoretical ex-rights price per share for Kumasi Lubricants Plc's rights issue to fund new equipment.

FM – L2 – Q28 – Sources of finance: equity

Calculate the theoretical ex-rights price per share for a company's 1 for 4 rights issue to finance new plant and equipment.

FM – L2 – Q27a – Portfolio Theory and CAPM

Calculate the average rate of return for two stocks over five years.

FM – L2 – Q25 – Portfolio theory and the capital asset pricing model (CAPM)

Calculate expected return and risk for two projects and advise on investment choice based on risk-return tradeoff.

FM – L2 – Q23 – Portfolio theory and CAPM

Calculate mean and standard deviation of expected return for Security X based on economic states.

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

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FM – L2 – Q33 – Dividend policy

Suggest share price for Kumasi Transport PLC based on 25% dividend payout using dividend growth model.

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FM – L2 – Q32 – Sources of finance

Explain key features and appropriate uses of equity, venture capital, business angels, private equity funds, and bonds as sources of finance.

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FM – L2 – Q31 – Sources of finance: debt

Calculate the change in EPS if convertible bonds are converted into equity shares for a company with given financial data.

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FM – L2 – Q30 – Financial markets

Outline advantages/disadvantages of stock exchange listing and types of issue costs associated.

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FM – L2 – Q29 – Sources of finance: equity

Calculate the theoretical ex-rights price per share for Kumasi Lubricants Plc's rights issue to fund new equipment.

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FM – L2 – Q28 – Sources of finance: equity

Calculate the theoretical ex-rights price per share for a company's 1 for 4 rights issue to finance new plant and equipment.

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FM – L2 – Q27a – Portfolio Theory and CAPM

Calculate the average rate of return for two stocks over five years.

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FM – L2 – Q25 – Portfolio theory and the capital asset pricing model (CAPM)

Calculate expected return and risk for two projects and advise on investment choice based on risk-return tradeoff.

You're reporting an error for "FM – L2 – Q25 – Portfolio theory and the capital asset pricing model (CAPM)"

FM – L2 – Q23 – Portfolio theory and CAPM

Calculate mean and standard deviation of expected return for Security X based on economic states.

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FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

You're reporting an error for "FM – L2 – Q21 – Discounted cash flow"

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