FINANCIAL MANAGEMENT – Page 9

FM – L2 – Q48 – Sources of finance: debt

Explain Public Private Partnership, discuss its guiding principles, and outline challenges to its use in Ghana.

Question

PUBLIC PRIVATE PARTNERSHIP

Governments may explore new public financing initiatives for the provision of public infrastructure and services. Public Private Partnership (PPP) is a common vehicle used by governments to achieve this objective.

Required:
(a) Explain the term Public Private Partnership.
(b) Discuss the principles guiding the use of the Public Private Partnership.
(c) What are the challenges to the use of PPP in Ghana?

Answer

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Tags: Financial management, Ghana, Infrastructure Financing, Local Content, PPP, Private Sector, Public Private Partnership, Public Sector, Risk Allocation, Value for Money
Level: Level 2

Topic: Sources of finance: debt

FM – L2 – Q46 – Economic and regulatory environment

Explain the constitutional provision on taxation in Zamunda.

Question

GOVERNMENT SOURCES OF REVENUE

A critical task of government in public financial management is raising revenues for development as the success of government’s programmes and projects depends large on the availability of funds. The central government raises money from taxes, non-tax revenues and grants.

Required:

(a) Explain the Constitutional provision on Taxation.

(b) Explain FOUR objectives of taxation other than for revenue mobilisation.

Answer

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Tags: Consumer Behavior, Economic Management, Fiscal Policy, Taxation, Wealth Redistribution
Level: Level 2

Topic: Economic and regulatory environment

FM – L2 – Q45 – Economic and regulatory environment

Explain five differences between public and private sector entities in an economy.

Question

(A). Explain FIVE differences between public sector entities and private sector entities.

(B). Explain the differences between public goods and services and private goods and services.

(C). Explain the distinguishing features of public enterprises.

Answer

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Tags: Autonomy, Government Business Enterprises, Profitability, Public Enterprises
Level: Level 2

Topic: Economic and regulatory environment

FM – L2 – Q40 – Capital structure

Calculate optimal gearing level and WACC for a company given varying costs of debt, ungeared equity beta, and tax rate.

Question

A company has estimated that its cost of debt capital varies according to the level of gearing, as follows:

Gearing	Cost of debt
20	5.0
30	5.4
40	5.8
50	6.5
60	7.2

Gearing is measured as the market value of the company’s debt as a proportion of the total market value of its equity plus debt.
The rate of tax is 30%. The ungeared equity beta factor for the company is 0.90. The risk-free rate of return is 4% and the return on the market portfolio is 9%.

Required:
Identify the optimal gearing level and WACC.

Answer

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Tags: Capital structure, CAPM, Cost of Equity, Financial Risk, Gearing, Optimal capital structure, Tax shield, Weighted Average Cost of Capital
Level: Level 2

Topic: Capital structure

FM – L2 – Q39 – Cost of capital

Calculate change in EPS for Kwadu Cocoa Plc after introducing a new production process with increased fixed costs and reduced variable costs, financed by debentures.

Question

Kwadu Cocoa Plc produces and sells a single product. The company has issued share capital of 800,000 equity shares of GH₵1 each. For the year ended 31st March Year 4, the company sold 60,000 units of the product at a price of GH₵30 each.

The statement of profit or loss for the year to 31st March Year 4 is as follows:

	GH₵’000	GH₵’000
Sales		1,800
Variable costs	720
Fixed costs	360
		1,080
Net profit before interest and tax		720
Minus interest payable		190
Net profit before tax		530
Tax at 35%		186
Net profit after tax		344

The company has decided to introduce a new automated production process, in order to improve efficiency. The new process will increase annual fixed costs by GH₵120,000 (including depreciation) but will reduce variable costs by GH₵7 per unit. There will be no increase in annual sales volume.

The new production process will be financed by the issue of GH₵2,000,000 12.5% debentures.

Required:
(a) Calculate the change in earnings per share if the company introduces the new production process.

(b) Assume that the company introduces the new production process immediately on 1st April Year 5. Calculate for the year to 31st March Year 5:

(i) the degree of operating gearing

(ii) the degree of financial gearing

(iii) the combined gearing effect.

Answer

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Tags: Capital structure, Combined gearing, Financial gearing, Financial Risk, Operating gearing
Level: Level 2

Topic: Capital structure

FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

Question

Akomo Plastics Plc is engaged in plastics manufacture. It is now considering a new investment that would involve diversification into chemicals manufacture, where the business risk is very different from the plastics manufacturing industry.
Research has produced the following information about three companies currently engaged in chemicals manufacturing, in the same part of the industry that Akomo Plastics Plc is planning to invest.

Company	Equity beta	Financed by:
A	2.66	40% equity capital, 60% debt capital
B	1.56	75% equity capital, 25% debt capital
C	1.45	80% equity capital, 20% debt capital

Akomo Plastics Plc is financed by 60% equity capital and 40% debt capital, and would intend to maintain this same capital structure if the new capital investment is undertaken.
The risk-free rate of return is 5% and the return on the market portfolio is 9%. Tax is at the rate of 25%. You should assume that the debt capital of Akomo Plastics Plc and Companies A, B and C is risk-free.

Required
(a) Calculate a suitable cost of equity for the proposed investment by Akomo Plastics Plc in chemicals manufacturing.

(b) Suggest a weighted average cost of capital that should be used to carry out an investment appraisal (NPV calculation) of the proposed project.

Answer

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Tags: Asset beta, Capital structure, CAPM, Chemical manufacturing, Cost of Equity, Equity beta, Financial Risk, investment appraisal, Tax shield, WACC
Level: Level 2

Topic: Cost of capital

FM – L2 – Q37 – Capital structure

Calculate the total value of a geared company and its equity value using Modigliani and Miller's theory after issuing debt to repurchase shares.

Question

A company has 4,000,000 equity shares in issue. The shares have a current market value of GH¢10 each. The company is considering whether to issue GH¢15,000,000 of debt finance and use the cash to buy back and cancel some equity shares. The tax rate is 30%.

According to Modigliani and Miller, if the company decided to issue the debt capital and repurchase shares, what would be:

(a) the total value of the geared company, and (3 marks)

(b) the value of equity in the company? (3 marks)

Answer

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Tags: Capital structure, Company valuation, Debt Finance, Equity valuation, Gearing, Modigliani and Miller
Level: Level 2

Topic: Capital structure

FM – L2 – Q36 – Sources of finance: equity

Prepare profit/loss statements, calculate EPS, and determine gearing for three financing schemes for Brighton Enterprises' expansion.

Question

Brighton Enterprises wishes to expand its production facilities to meet an increase in sales demand for its products. It will need GH₵18 million of new capital to invest in equipment. It is expected that annual profit before interest and taxation will increase by GH₵5 million.
Brighton Enterprises is considering the following three possible methods of financing the expansion programme:
(i) Issuing 9 million GH₵0.50 equity shares at a premium of GH₵1.50 per share.
(ii) Issuing 12 million 12% GH₵1 preference shares at par and GH₵6 million 10% debentures at par.
(iii) Issuing 6 million equity shares at a premium of GH₵1.50 per share and GH₵6 million 10% debentures at par.

Assume that the rate of tax on profits is 25%.

The statement of financial position of Brighton Enterprises as at 31st November Year 6 is as follows:

Statement of financial position as at 30th November Year 6

	GH₵m	GH₵m
Non-current assets		24.8
Current assets
Inventory	18.5
Trade receivables	21.4
Bank	1.9
		41.8
Total assets		66.6
Equity and liabilities
GH₵0.50 ordinary shares		10.0
Accumulated profits		22.4
Total equity		32.4
10% Debentures		15.0
Current liabilities
Trade payables
Taxation
		19.2
Total equity and liabilities		66.6

A statement of profit or loss for the year to 30th November Year 6 is as follows:

	GH₵m
Sales	115.4
Profit before interest and taxation	17.9
Interest payable	1.5
Profit before taxation	16.4
Tax (25%)	4.1
Profit after taxation	12.3

Required
(a) For each of the financing schemes under consideration:
(i) prepare a projected statement of profit or loss for the year ended 30 November Year 7.
(ii) calculate the expected earnings per share for the year ended 30th November Year 7.
(iii) calculate the expected level of financial gearing as at 30th November Year 7, assuming that dividend payments during the year are GH₵0.30 per share.

(b) Assess each of the three financing schemes under consideration from the viewpoint of an existing equity shareholder in Brighton Enterprises.

Answer

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Tags: Debt financing, Earnings per share, Equity financing, Financial gearing, Financing schemes, Shareholder perspective
Level: Level 2

Topic: Sources of finance: equity

FM – FM – L2 – Q35 – Capital structure

Analyze gearing impact on two companies' EPS and financial risk using provided financial data.

Question

The following information is available about Company A and Company B:

	Company A	Company B
Capital structure	GH¢	GH¢
Equity shares of GH¢1	10,000	10,000
Reserves	20,000	90,000
10% debt capital	30,000	—
	60,000	100,000
	100,000	100,000

| Annual profit | | | | Sales | 80,000 | 80,000 |

| Variable costs | 40,000 | 40,000 |

| Contribution | 40,000 | 40,000 |

| Fixed operating costs | 10,000 | 10,000 |

| Profit before interest and tax | 30,000 | 30,000 |

| Interest costs | 3,000 | — | | Profit | 27,000 | 30,000 |

| Tax (20%) | 5,400 | 6,000 |

| Profit after tax (= earnings after interest and tax) | 21,600 | 24,000 |

Required:

(a) Calculate the earnings per share for Company A and Company B.

(b) Calculate the level of profit before interest and tax at which the earnings per share for Company A will be equal to the earnings per share for Company B.

Answer

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Tags: Capital structure, Debt, Earnings per share, Equity, Financial Risk, Gearing, Profit after tax
Level: Level 2

Topic: Capital structure

FM – L2 – Q34 – Dividend policy

Analyze dividend policy of Kumasi Freight Plc from 20X1-20X5 and estimate share price under four dividend options.

Question

Question Tags: Dividend policy, Share valuation, Earnings retention, Shareholder returns, Financial strategy
Question Short Summary: Analyze dividend policy of Kumasi Freight Plc from 20X1-20X5 and estimate share price under four dividend options.

———————————————————–
Question:
The table below shows earnings and dividends for Kumasi Freight Plc over the past five years.

Year	Net earnings per share	Dividend per share
	GH¢	GH¢
20X1	1.40	0.84
20X2	1.35	0.88
20X3	1.35	0.90
20X4	1.30	0.95
20X5	1.25	1.00

There are 10,000,000 shares issued and the majority of these shares are owned by private investors. There is no debt in the capital structure.
It is clear from the table that the company has experienced difficult trading conditions over the past few years. In the current year, net earnings are likely to be GH¢10 million, which will be just sufficient to pay a maintained dividend of GH¢1 per share.
Members of the board are considering a number of strategies for the company, some of which will have an impact on the company’s future dividend policy.
The company’s shareholders require a return of 15% on their investment.
Four options are being considered, as follows:
(1) Pay out all earnings as dividends.
(2) Pay a reduced dividend of 50% of earnings and retain the remaining 50% for future investment.
(3) Pay a reduced dividend of 25% of earnings and retain the remaining 75% for future investment.
(4) Retain all earnings for an aggressive expansion programme and pay no dividend at all.
The directors cannot agree on any of the four options discussed so far. Some of them prefer option (1) because they believe to do anything else would have an adverse impact on the share price. Others favour either option (2) or option (3) because the company has identified some good investment opportunities and they believe one of these options would be in the best long-term interests of shareholders. An adventurous minority favours option (4) and thinks this will allow the company to take over a small competitor.

Required:
(a) Comment on the company’s dividend policy between 20X1 and 20X5 and on its possible consequences for earnings.
(b) Advise the directors of the share price for Kumasi Freight Plc which might be expected immediately following the announcement of their decision if they pursued each of the four options, using an appropriate valuation model. You should also show what percentage of total return is provided by dividend and capital gain in each case. You should ignore taxation for this part of the question. Make (and indicate) any realistic assumptions you think necessary to answer this question.

Answer

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Tags: Dividend Policy, Earnings retention, Financial strategy, Share valuation, Shareholder returns
Level: Level 2

Topic: Dividend policy

Subject (SQ): FINANCIAL MANAGEMENT

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FM – L2 – Q48 – Sources of finance: debt

Explain Public Private Partnership, discuss its guiding principles, and outline challenges to its use in Ghana.

FM – L2 – Q46 – Economic and regulatory environment

Explain the constitutional provision on taxation in Zamunda.

FM – L2 – Q45 – Economic and regulatory environment

Explain five differences between public and private sector entities in an economy.

FM – L2 – Q40 – Capital structure

Calculate optimal gearing level and WACC for a company given varying costs of debt, ungeared equity beta, and tax rate.

FM – L2 – Q39 – Cost of capital

Calculate change in EPS for Kwadu Cocoa Plc after introducing a new production process with increased fixed costs and reduced variable costs, financed by debentures.

FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

FM – L2 – Q37 – Capital structure

Calculate the total value of a geared company and its equity value using Modigliani and Miller's theory after issuing debt to repurchase shares.

FM – L2 – Q36 – Sources of finance: equity

Prepare profit/loss statements, calculate EPS, and determine gearing for three financing schemes for Brighton Enterprises' expansion.

FM – FM – L2 – Q35 – Capital structure

Analyze gearing impact on two companies' EPS and financial risk using provided financial data.

FM – L2 – Q34 – Dividend policy

Analyze dividend policy of Kumasi Freight Plc from 20X1-20X5 and estimate share price under four dividend options.

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FM – L2 – Q48 – Sources of finance: debt

Explain Public Private Partnership, discuss its guiding principles, and outline challenges to its use in Ghana.

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FM – L2 – Q46 – Economic and regulatory environment

Explain the constitutional provision on taxation in Zamunda.

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FM – L2 – Q45 – Economic and regulatory environment

Explain five differences between public and private sector entities in an economy.

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FM – L2 – Q40 – Capital structure

Calculate optimal gearing level and WACC for a company given varying costs of debt, ungeared equity beta, and tax rate.

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FM – L2 – Q39 – Cost of capital

Calculate change in EPS for Kwadu Cocoa Plc after introducing a new production process with increased fixed costs and reduced variable costs, financed by debentures.

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FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

You're reporting an error for "FM – L2 – Q38 – Cost of capital"

FM – L2 – Q37 – Capital structure

Calculate the total value of a geared company and its equity value using Modigliani and Miller's theory after issuing debt to repurchase shares.

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FM – L2 – Q36 – Sources of finance: equity

Prepare profit/loss statements, calculate EPS, and determine gearing for three financing schemes for Brighton Enterprises' expansion.

You're reporting an error for "FM – L2 – Q36 – Sources of finance: equity"

FM – FM – L2 – Q35 – Capital structure

Analyze gearing impact on two companies' EPS and financial risk using provided financial data.

You're reporting an error for "FM – FM – L2 – Q35 – Capital structure"

FM – L2 – Q34 – Dividend policy

Analyze dividend policy of Kumasi Freight Plc from 20X1-20X5 and estimate share price under four dividend options.

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