Subject: ADVANCED FINANCIAL MANAGEMENT

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  • 20 Marks

FR – May 2018 – L2 – Q4 – Consolidated Financial Statements (IFRS 10)

Assess the financial performance and position of two companies using specified ratios and explain the limitations of ratio analysis.

Ibadan Nigeria Limited is considering acquiring a suitable private limited liability company. The board of directors engaged a financial consultant to analyze the financial position of two companies, Abuja Limited and Rivers Limited, which are both receptive to the acquisition. The draft financial statements of the two companies are as follows:

Statements of Profit or Loss

a. Draft a report to the chairman of the board of directors of Ibadan Limited to assess the financial performance and position of the two companies using the following specific ratios: (12 Marks) i. Profitability ratios: Gross profit percentage and net profit margin. ii. Liquidity ratios: Acid test ratio, current ratio, trade receivable period. iii. Long-term financial stability ratios: Gearing ratio and proprietary ratio. iv. Efficiency ratios: Total asset turnover and non-current asset turnover.

b. Explain the limitations of ratio analysis and further information that may be useful to the board of directors when making the acquisition decision. (8 Marks)

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  • 5 Marks

AFM – Nov 2016 – L3 – Q5b – Emerging issues in finance and financial management

Compare the functions of the IMF and World Bank and outline challenges faced by the IMF in West Africa.

The International Monetary Fund (IMF) and the World Bank are institutions in the United Nations system. They are twin intergovernmental pillars supporting the structure of the world’s economic and financial order.

Required:
i) Compare and contrast THREE functions of the International Monetary Fund (IMF) and the World Bank. (3 marks)
ii) Explain TWO challenges being faced by the IMF in attaining its objectives in West African Countries. (2 marks)

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  • 15 Marks

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

YSL is a company located in the USA that has a contract to purchase goods from Japan in two months’ time on 1st September. The payment is to be made in yen and will total 140 million yen. The managing director of YSL wishes to protect the contract against adverse movements in foreign exchange rates and is considering the use of currency futures. The following data are available:

  • Spot foreign exchange rate: $1 = 128.15 yen
  • Yen currency futures contracts on SIMEX (Singapore Monetary Exchange)
    • Contract size: 12,500,000 yen
    • Contract prices (US$ per yen):
      • September: 0.007985
      • December: 0.008250

Assume that futures contracts mature at the end of the month.

Required:
i) Illustrate how YSL might hedge its foreign exchange risk using currency futures. (5 marks)
ii) Explain the meaning of basis risk and show what basis risk is involved in the proposed hedge. (5 marks)
iii) Assuming the spot exchange rate is 120 yen/$1 on 1 September and that basis risk decreases steadily in a linear manner, calculate what the result of the hedge is expected to be. Briefly discuss why this result might not occur. (5 marks)
(Margin requirements and taxation may be ignored.)

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  • 6 Marks

AFM – Nov 2016 – L3 – Q4b – Financial strategy formulation

Discuss three advantages and three disadvantages of ABC Ltd being acquired in a leveraged buyout (LBO).

ABC Ltd is a listed company that operates in the Information Technology industry. The company has been experiencing losses for several years now, and its reserves are fast depleting. Its earnings per share have been negative for the past three years. A team of the company’s largest shareholders and some managers are considering acquiring the company in a leveraged buy-out (LBO).

Required:
Discuss THREE advantages and THREE disadvantages of ABC Ltd being acquired in an LBO.

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  • 14 Marks

AFM – Nov 2016 – L3 – Q4a – Valuation of acquisitions and mergers

Calculate the NPV of Mama Ltd's acquisition of Papa Ltd and determine the value of the combined entity and an appropriate share exchange ratio.

a) The Directors of Mama Ltd (Mama), a large listed company, are considering an opportunity to
acquire all the shares of Papa Ltd (Papa), a small listed company with a highly efficient
production technology.
Mama has 10 million shares of common stock in issue that are currently trading at GH¢6.00
each. Papa Ltd has 5 million shares of common stock in issue, each of which is trading at
GH¢4.50.
If Papa is acquired and integrated into the business of Mama, the production efficiency of the
combined entity would increase and save the combined business GH¢600,000 in operating
costs each year to perpetuity.
Though Mama operates in the same industry as Papa, its financial leverage is higher than that
of Papa. Mama’s total debt stock is valued at GH¢40 million, and its after-tax cost of debt is
22%. The beta of Mama’s common stock is 1.2. The return on the risk-free asset is 20% and
the market risk premium is 5%.
Required:
Suppose Mama offers a cash consideration of GH¢25 million from its existing funds to the
shareholders of Papa for all of their shares.
i) Calculate the NPV of the acquisition, and advise the directors of Mama on whether to
proceed with the acquisition or not. (8 marks)
ii) Calculate the value of the combined entity immediately after the acquisition. (3 marks)
iii) Suppose Mama would like to acquire all the shares in Papa by offering fresh shares of its
own common stock to the shareholders of Papa. Advise the directors on the appropriate
share exchange ratio based on market price.

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  • 10 Marks

AFM – May 2017 – L3 – Q5b – Treasury and Advanced Risk Management Techniques

Explanation of internal and external factors influencing transfer pricing decisions for multinational companies like Kofas Ltd.

One of the key considerations for multinational companies is to decide on the price at which goods and services are transferred from one member of a group to another.

Kofas Ltd has been operating in four countries: Ghana, Nigeria, UK, and USA. The parent company and the subsidiaries have decided to use a transfer pricing policy.

Required:
You have been approached as a consultant to advise on the internal and external factors that will facilitate the transfer of goods and services from one member of the group to another. (10 marks)

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  • 10 Marks

AFM – May 2017 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Calculation of settlement value, loan amount, interest on loan, and effective interest rate under a Forward Rate Agreement.

The Board of Directors of Aduana Enterprise has approved an expansion project which will require a cash inflow of GH¢10 million. The investment duration will be 6 months, and management is considering taking a fixed interest rate loan from its bankers. The loan will be required in three months from the date of board’s approval.

Management of Aduana is considering hedging its risk exposure using a Forward Rate Agreement (FRA). The 3-9 months’ FRA rate at the transaction date was 5%.

Required:
If the spot rate at the settlement date is 8%, calculate the following:
i) Settlement value (3 marks)
ii) Loan amount required (2 marks)
iii) Interest on the loan (2 marks)
iv) Effective interest rate (3 marks)

 

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  • 10 Marks

AFM – May 2017 – L3 – Q4b – Financial reconstruction, Business reorganisation

Distinguishing between leveraged buy-out and recapitalization, identifying types of reconstruction, and describing steps in financial reconstruction.

There are many possible reasons why management would wish to restructure a company’s finances. A reconstruction scheme might be agreed upon when a company is in danger of being put into liquidation.

Required:
i) Distinguish between a leveraged buy-out and leveraged recapitalisation. (4 marks)
ii) What are the THREE main types of reconstruction? Describe them briefly. (3 marks)
iii) Describe the procedures that should be followed when designing a financial reconstruction scheme. (3 marks)

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  • 10 Marks

AFM – May 2017 – L3 – Q4a – Sources of finance and cost of capital

Explanation of Eurobonds, their advantages, and problems associated with their use in Ghana's international borrowing.

The government of Ghana has been borrowing in the international financial market by issuing “Eurobonds” to finance projects in Ghana. There has been a keen debate on the borrowing by the government.

Required:
i) As a Finance Officer, explain what Eurobond is all about. (3 marks)
ii) Identify THREE advantages that have been cited for the government using Eurobonds. (3 marks)
iii) Evaluate FOUR problems associated with the use of international borrowing, especially Eurobonds in Ghana. (4 marks)

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  • 4 Marks

AFM – May 2017 – L3 – Q3c – Valuation of acquisitions and mergers

Factors to be considered by the directors and shareholders in evaluating the worthiness of the takeover proposal.

Discuss briefly any other factors that the directors and shareholders of both companies might consider in assessing the worthwhileness of the proposed takeover. (4 marks)

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  • 12 Marks

AFM – Nov 2016 – L3 – Q3b – Discounted cash flow techniques

Calculate the Net Present Value (NPV) of a new product investment project considering real terms and inflation adjustments.

A company plans to invest GH¢7 million in a new product. Net contribution over the next five years is expected to be GH¢4.2 million per annum in real terms. Marketing expenditure of GH¢1.4 million per annum will also be needed. Expenditure of GH¢1.3 million per annum will be required to replace existing assets, and additional investment in working capital, equivalent to 10% of contribution, will be needed at the start of each year. Working capital will be released at the end of the project. The following inflation forecasts are made for the next five years:

  • Contribution: 8%
  • Marketing: 3%
  • Assets: 4%
  • General prices: 4.70%

The real cost of capital is 6%. All cash flows are in real terms. Ignore tax.

Required:
Calculate the Net Present Value (NPV) of the project and appraise whether it is a worthwhile project.

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  • 16 Marks

AFM – May 2017 – L3 – Q3a & b – Valuation of acquisitions and mergers

Calculating the maximum and minimum prices for Jacobs Ltd's acquisition of Idowu Co Ltd based on future revenue and cost synergies.

Jacobs Limited and Idowu Company Limited both manufacture and sell auto parts. The summarised profit and loss accounts of the two companies for 2014 are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Sale Revenue 1,500 800
Operating Expenses (800) (620)
Profit 700 180

Each company has earned a constant level of profit for a number of years, and both are expected to continue to do so. The policy of both companies is to distribute all profits as dividends to ordinary shareholders as they are earned. Neither company has any fixed interest capital. Details of the ordinary share capital of the two companies are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Authorised Ordinary Shares 2,500 2,000
Issued Ordinary Shares 2,000 1,000
Market Value per Share (Ex Div) 3.50 1.50

The directors of Jacobs Limited are considering submitting a bid for the entire share capital of Idowu Co Limited. They believe that, if the bid succeeds, the combined sales revenue of the two companies will increase by GH¢60,000 per annum, and savings in operating expenses, amounting to GH¢50,000 per annum, will be possible. Part of the machinery at present owned by Idowu Co Limited would no longer be required and could be sold for GH¢100,000. Furthermore, the directors of Jacobs Limited believe that the takeover would result in a reduction to 9% in the annual return required by the ordinary shareholders of Idowu Co Limited.

Required:
i) On the basis of the above information, calculate the maximum price that Jacobs Ltd should be willing to pay for the entire share capital of Idowu Co Limited. (6 marks)
ii) Calculate the minimum price that the ordinary shareholders in Idowu Co Ltd should be willing to accept for their shares. (4 marks)

Assume that the takeover price is agreed at the figure calculated in part (ii) above, and that the purchase consideration will be settled by an exchange of ordinary shares in Idowu Co Ltd for the ordinary shares of Jacobs Ltd. Show how the entire benefit from the takeover will accrue to all the present shareholders of Jacobs Ltd. (6 marks)

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  • 8 Marks

AFM – Nov 2016 – L3 – Q3a – Sources of finance and cost of capital

Calculate the cost of equity for Sunland Co using the Capital Asset Pricing Model (CAPM) with a focus on deriving beta from industry data.

a) The directors of Sunland Company, a company which has 75% of its operations in the retail
sector and 25% in manufacturing, are trying to derive the firm’s cost of equity. However, since
the company is not listed, it has been difficult to determine an appropriate beta factor. The
following information was researched:

  •  Retail industry – quoted retailers have an average equity beta of 1.20, and an average
    gearing ratio of 20:80 (debt: equity).
  • Manufacturing industry – quoted manufacturers have an average equity beta of 1.45 and
    an average gearing ratio of 45:55 (debt: equity).
  • The risk free rate is 3% and the equity risk premium is 6%.
  • Tax on corporate profits is 30%.
  •  Sunland Co has gearing ratio of 50% debt and 50% equity by market values. Assume that
    the risk on corporate debt is negligible.

Required:
Calculate the cost of equity of Sunland Company using the Capital Asset Pricing Model.

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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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  • 10 Marks

AFM – May 2019 – L3 – Q5b – Valuation and use of free cash flows

Evaluate whether Senchi Ltd is a good investment for Kurablah based on the Dividend Growth Model and calculate the maximum price she should pay.

Rosa Kurablah Ltd (Kurablah) plans to invest in ordinary shares for a period of fifteen years, after which she will sell out, buy a lifetime room and board membership in a retirement home, and retire. She feels that Senchi Ltd (Senchi) is currently, but temporarily, undervalued by the market. Kurablah expects Senchi’s current earnings and dividend to double in the next fifteen years. Senchi’s last dividend was GH¢3, and its stock currently sells for GH¢35 a share.

Required:

i) If Kurablah requires a 12 percent return on her investment, will Senchi be a good buy for her?
(3 marks)

ii) What is the maximum that Kurablah could pay for Senchi and still earn her required 12 percent?
(2 marks)

iii) What might be the cause of such a market undervaluation?
(3 marks)

iv) Given Kurablah’s assumptions, what market capitalization rate for Senchi does the current price imply?

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  • 6 Marks

AFM – Nov 2016 – L3 – Q2b – International investment and financing decisions

Compare the advantages and disadvantages of setting up a subsidiary versus licensing for KK Chemicals and suggest ways to mitigate blocked funds risk.

KK Chemicals Ltd, an Accra-based manufacturer of paints, sells its products only in Ghana. Currently, the company wants to expand into other African countries. The directors are considering two options: setting up its own subsidiary company to manufacture and sell the products or licensing a company based in the host country to manufacture and sell the products.

Required:
i) Advise the directors on TWO potential advantages and TWO disadvantages to KK Chemicals of setting up its own subsidiary company to handle production and sale in the host country as against licensing a company in the host country. (4 marks)

ii) Suppose KK Chemicals elects to set up a subsidiary in the host country. Suggest to the directors TWO ways of dealing with the risk of blocked funds. (2 marks)

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  • 10 Marks

AFM – May 2019 – L3 – Q5a – The role of the treasury function in multinationals

Calculate intragroup currency transfers through netting and discuss the pros and cons of using currency options versus futures for hedging net exposures.

Edi Ltd, based in Accra, Ghana, is a multinational company with two wholly-owned subsidiaries: Gil Plc based in Nigeria and Zep Ltd based in South Africa. Until recently, the Edi group has been doing well, returning a stable level of dividends to its shareholders. The financial performance of the Edi group has dipped in the past two years. In the last quarter of last year, the directors approved the establishment of a central treasury department based at the group’s headquarters in Accra. It is believed that the central treasury function will help boost effectiveness and efficiency in the group’s liquidity management, currency risk management, dividend remittances, and borrowing.

Intragroup Currency Transfers:
There are a lot of intragroup credit transactions that are often settled independently between the parties involved. This year, the treasury department has been tasked to manage the settlement of intragroup indebtedness through netting to reduce the volume of currency transactions. It has been agreed that all settlements will be made in the Ghanaian cedi at the prevailing spot mid-market exchange rate.

Below is a list of intragroup indebtedness at the end of the first quarter to be settled today:

Required:

i) Suppose the currency netting is implemented. Calculate the intragroup company currency transfers that will be required for settlement by each member of the Edi group.
(6 marks)

ii) Suppose the treasury department is recommending the use of currency futures to hedge net currency exposures. Discuss the advantages and disadvantages of the Edi group using currency options instead of currency futures in hedging net currency exposures.

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  • 14 Marks

AFM – Nov 2016 – L3 – Q2a – Dividend policy in multinationals and transfer pricing

Advise on factors affecting dividend policy and calculate GGML’s dividend capacity and payout ratio for the next three years.

You are the newly employed Finance Director of Gala Gold Mining Ltd (GGML), a fast
growing Ghanaian mining company. The ordinary shares of GGML are listed on the Ghana
Stock Exchange. The company issued two million fresh shares in an Initial Public Offer (IPO)
to meet the minimum public shareholding requirement of the Exchange. In the prospectus
accompanying the IPO, the company proposed a stable earnings pay-out ratio of 20%.
It has been one year since the listing of GGML’s ordinary shares. At the first post-listing annual
general meeting, which was held last week, the directors recommended that the company
retains the entire profit earned in its first year as a public company to help finance profitable
mining opportunities in the Western part of Ghana. This 100% earnings retention proposal was
rejected by the shareholders, and the directors have promised to reconsider the issue and
recommend some dividends.
The directors would be meeting in the coming month to discuss the matter with the hope of
developing a sustainable dividend policy for the next three years. You are expected to make a
presentation on the company’s dividend capacity at the meeting.
You have gathered relevant extracts from the financial results of the past financial year (i.e.
financial year ending June 2015) and expected annual changes in the values over the next three
years (i.e. financial years ending June 2016, 2017 and 2018) presented in the Table below :

The company’s tax rate is expected to remain at 35%.
Required:
i) Advise the directors on THREE factors they should consider in developing an appropriate
dividend policy for GGML. (6 marks)
ii) Calculate the maximum dividends GGML can pay for the past financial year, and estimate
its dividend capacity for the next three years. Recommend an appropriate dividend payout ratio for the coming three financial years.

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  • 12 Marks

AFM – May 2017 – L3 – Q2a – Discounted cash flow techniques

Use Macaulay duration method to choose the best bond option for ABE based on recovery period.

ABE has surplus cash which can be invested for at least five years. The company has consulted you to help them choose an investment that gives the shortest recovery period. The company presented the information on two types of bonds as follows:

Bond Redemption Nominal Value (GH¢) Redemption Value Coupon Rate (%) Price (GH¢)
A 5 years 1,000 At par 7.00 950
B 6 years 1,000 5% premium 7.50 1,010

Required:
Use the Macaulay Duration method to advise ABE on the best bond option to select for their investment. (12 marks)

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  • 12 Marks

AFM – May 2019 – L3 – Q4b – Dividend policy in multinationals and capital structure decisions

Evaluate the financing options for Asana Ltd’s expansion, calculate the value of a right, dividend capacity, and debt-to-equity ratio under different methods.

Asana Ltd (Asana) is a manufacturing company based in Ghana. It is listed on Ghana’s stock exchange with a total market capitalization of GH¢400 million and 50 million shares outstanding. Its debt stock is made up of 10,000 18% bonds with a face value of GH¢100 each. Per the bond indenture, Asana is required to maintain a maximum debt-to-equity ratio of 80% and is prohibited from paying a dividend in any year unless its dividend capacity for that year is at least 45% of net income for that year. For the past three years, the company has not been able to pay dividends to its shareholders because it has not been able to meet the minimum dividend capacity requirement.

Presently, the company is planning an expansion project that could enhance its dividend capacity for the coming years. The expansion project is expected to increase profit before interest and tax by 15% above the recent figure of GH¢35 million. The directors are considering whether to use equity or debt finance to raise the GH¢50 million required by the expansion project. The amount required for the business expansion will be invested in additional property and equipment. Details of the two financing methods under consideration follow:

Method 1: Equity Finance
If equity finance is used, Asana will offer 1 new share for every 4 existing shares in a rights offer at a discount of 10% off the current market price.

Method 2: Debt Finance
If debt finance is used, Asana will raise the required GH¢50 million through a syndicated loan arrangement. The interest rate on this syndicated loan is expected to be 20%. It is assumed that the entire principal will be drawn immediately and paid back in a lump sum in 5 years’ time.

Additional information:

  1. Presently, the book value of equity is GH¢200 million, while the debt level is GH¢100 million.
  2. The recent profit before interest and tax is reported after charging depreciation of GH¢10 million and profit on disposal of non-current assets of GH¢2 million. The aggregate cost of the non-current assets sold is GH¢10 million, and their aggregate accumulated depreciation is GH¢8 million.
  3. In addition to the business expansion expenditure, GH¢2 million will be invested to maintain existing productive capacity in the coming year. This will be financed from retained earnings.
  4. Additional investment in net working capital will be 20% of the current net working capital balance of GH¢100 million.
  5. Asana pays corporate income tax at 22%.

Required:

i) Supposing equity finance is used, compute the value of a right.
(2 marks)

ii) Forecast the dividend capacity of Asana under both financing methods after the business expansion. Conclude whether Asana would be able to pay dividends to its shareholders in the coming year.
(5 marks)

iii) Compute the revised debt-to-equity ratio of Asana under both financing methods after the business expansion.
(3 marks)

iv) Use the results of the calculations above to evaluate whether equity or debt finance should be used for the planned business expansion.
(2 marks)

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