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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  • 8 Marks

AFM – Nov 2018 – L3 – Q2b – International investment and financing decisions

Evaluate the impact of profit repatriation restrictions and provide strategies to deal with blocked funds in international investments.

Suppose the South African government changes its policy on profit repatriation and legislates that profit cannot be repatriated until termination or exit.

i) If Rock can invest blocked funds in South Africa for a 12% annual rate of return, by how much would the project’s NPV differ from your results in sub-question (a) above?
(5 marks)

ii) Suggest THREE (3) ways through which Rock can deal with the risk of blocked funds.
(3 marks)

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  • 20 Marks

AFM – May 2016 – L3 – Q5 – Corporate Reconstruction and Reorganisation, Business reorganization

Calculate the maximum possible loss of the company and allocate it between preference and ordinary shareholders.

Additional Information:

  • The realizable values of the assets are as follows:
    • Furniture & Fittings: GH¢27.0m
    • Motor Vehicle: GH¢67.5m
    • Land & Building: GH¢26.25m
    • Stocks: GH¢10.95m
    • Debtors: GH¢7.5m
  • The stated capital of the company is made up as follows:
    • 2,000,000 ordinary shares of no par value: GH¢67.5m
    • 500,000 15% cumulative preference shares of no par value: GH¢30.0m
  • The cost of winding up is estimated at GH¢21.3m.
  • The bank overdraft and 18% debentures are secured by a floating charge on the company’s assets.
  • The preference dividends and interest on debentures are two years in arrears. However, no provision has been made for these in the financial statement.
  • The ordinary shareholders have decided to inject GH¢60.0m in consideration for a new issue of equity shares if the capital reconstruction scheme is accepted.
  • Although it is the company’s policy to amortize intangible assets over five years, the Board of Directors has decided to maintain the Goodwill indefinitely in the books due to the persistent losses, in contravention of the company’s policy. Goodwill has been outstanding since 2009. The current financial state of the company negates the value and existence of the goodwill.
  • The preference shareholders have indicated their willingness to bear any deficit resulting from the reconstruction in proportion to their interest in the stated capital. In return, their stake would be converted into equity, and they would be permitted to make nominations to key management positions, including chairing the board for the first five years. If these proposals are accepted, the preference shareholders will contribute further equity of GH¢60.0m. They have also agreed to waive 50% of the arrears of dividend and convert the rest into equity.
  • Any arrears of preference dividends are to form a first charge upon any surplus on winding up.
  • The original ordinary shareholders have decided to waive any dividend due to them during the first two years in order to put the company on sound financial ground.
  • The company is expected to improve its cash flow position and commence dividend payments if the additional capital of GH¢120.0m is introduced.

Required:
a) Calculate the amount available if Crave Cottage Industry Limited is liquidated and its distribution.

(7 marks)
b) Calculate the maximum possible loss of Crave Cottage Industry Limited and its allocation to Preference Share Capital and Ordinary Share Capital. (6 marks)
c) Calculate the Bank/Cash balance of Crave Cottage Industry Limited after the reorganization. (2 marks)
d) Calculate the new stated capital for the company after the reorganization. (2 marks)
e) Prepare a Statement of Financial Position of Crave Cottage Industry Limited showing the position immediately after the scheme has been put in place.

(3 marks)

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  • 12 Marks

AFM – Nov 2018 – L3 – Q2a – International investment and financing decisions

Evaluate an international mining investment opportunity in South Africa using NPV approach for financial feasibility.

Rock Minerals Ltd (Rock) is a minerals mining company based in Ghana. Rock is considering an investment opportunity in South Africa, which involves developing and operating a gold mine and later transferring the mine to the South African government.

Last year, the directors commissioned a special committee to assess investments and regulatory requirements relating to the project. Based on the committee’s report, the directors estimate that it will take two years to develop the mine. Development of the mine entails an immediate outlay of ZAR1.2 million in regulatory requirement expenditures, an investment of ZAR20 million in plants and equipment in the first year, and ZAR15 million for development expenditure in the second year. The directors also estimate that Rock will invest ZAR2 million in net working capital at the beginning of the third year. The investment in net working capital is expected to be increased to ZAR3 million at the beginning of the fifth year.

Commercial production and sales are expected to begin in the third year. Below are estimated operating cash flows before tax in the first three years of commercial production:

Year Revenue collections (ZAR’ millions) Variable operating costs (ZAR’ millions) Fixed operating costs (ZAR’ millions)
3 100 40 20
4 150 50 25
5 210 80 30

At the end of the fifth year, Rock will transfer ownership and control of the mine to the South African government for an after-tax consideration of ZAR100 million. The special committee also reports that the income tax rate for mining operations is 30%, and capital expenditure in relation to acquisition of property, plant, and equipment, and development expenditure qualifies for capital allowance at the rate of 20% per annum on a straight-line basis. Capital allowance is granted at the end of each year of commercial production. On repatriation of profit, the committee reports that the South African government does not restrict the repatriation of profit, and there are no profit repatriation taxes. Rock would repatriate cash returns as they become available.

Rock plans to finance this project using existing capital. Rock’s after-tax cost of capital is 25% in Ghana. The annual rate of inflation is expected to be 11% in Ghana and 5% in South Africa in the coming years. Currently, the rate of exchange between the Ghanaian cedi (GH¢) and the South African rand (ZAR) is GH¢0.3822 = ZAR1.

Required:
Evaluate the project on financial grounds using the net present value (NPV) approach and recommend whether the investment proposal should be accepted for implementation or not.
(12 marks)

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  • 20 Marks

AFM – Nov 2015 – L3 – Q2 – Discounted Cash Flow Techniques | Sources of Finance and Cost of Capital

Evaluate the financial viability of a proposed air conditioner manufacturing project using APV.

ABC Manufacturing Ltd (ABC) is an indigenous Ghanaian company that manufactures components used in air conditioners. The company now wants to manufacture air conditioners for sale in Ghana. Though the manufacture of air conditioners will be a completely new business, directors of ABC plan to integrate it into the company’s core business.

ABC has premises it considers suitable for the project. This premises was acquired two years ago at the cost of GHS50,000. ABC will acquire and install the needed machinery immediately, so production and sales can commence during the first year. The directors of ABC intend to develop the project for five years and then sell it to a suitable investor for an after-tax consideration of GHS20 million.

The following data are available for the project:

  1. The cost of acquiring and installing plant and machinery needed for the project will be GHS5 million at the start of the first year. Tax-allowable depreciation is available on the plant and machinery at the rate of 30% on reducing balance basis.
  2. Working capital requirement for each year is equal to 10% of the year’s anticipated sales. ABC has to make working capital available at the beginning of the respective year. It is expected that 40% of working capital will be redeployed to other projects at the end of the fifth year when the project is sold.
  3. It is expected that 2,000 units will be manufactured and sold in the first year. Unit sales will grow by 5% each year thereafter.
  4. Unit sales price is estimated at GHS2,200 in the first year. Thereafter, the unit sales price is expected to be increased by 10% each year.
  5. Unit variable cost will be GHS1,100 per unit in the first year. Unit variable cost is expected to increase by 8% each year after the first year.
  6. Fixed overhead costs are estimated at GHS1.5 million in total in each year of production/sale. One-half of the total fixed overhead costs are head office allocated overheads. After the first year of production/sales, fixed overhead costs are expected to increase by 5% per year.

ABC Ltd pays tax at 25% on taxable profits. Tax is payable in the same year the profit is earned. ABC Ltd uses 25% as its discount rate for new projects but the directors feel that this rate may not be appropriate for this new venture.

Currently, ABC can borrow at 500 basis points above the five-year Treasury note yield rate. Ghana’s government is enthused by the venture and has offered ABC a subsidized loan of up to 60% of the investment funds required at an interest rate of 200 basis points above the five-year Treasury note yield rate. ABC plans to use debt capital to finance the project by taking advantage of the government’s subsidized loan and raising the balance through a fresh issue of 5-year debentures. Issues costs, which can be assumed to be tax-deductible expenses, will be 5% of the gross proceeds from the debenture offer. The financing strategy for the project is not expected to affect the company’s borrowing capacity in any way.

ABC Ltd will be the first indigenous Ghanaian company to manufacture air conditioners in Ghana. However, it will be competing with XYZ Ltd, a listed company with majority shares held by foreign investors. The cost of equity of XYZ Ltd is estimated to be 20% and it pays tax at 22%. XYZ has 10 million shares in issue that are trading at GHS5.5 each, and bonds with total market value of GHS40 million.

The five-year Treasury note yield rate is currently 10% and the return on the market portfolio is 18%.

Required:
Evaluate, on financial grounds, whether ABC should implement the project or not. (20 marks)

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  • 20 Marks

AFM – Nov 2018 – L3 – Q1b – Economic environment for multinational organisations

Advising One-Village on the risks associated with a proposed irrigation project in a Sub-Saharan African country based on the World Bank Doing Business Report.

The directors of One-Village are considering another irrigation project in a country in Sub-Saharan Africa. The World Bank’s Doing Business Report for 2017 ranked the destination country 140th out of 190 countries on the ease of doing business. Below is the ease of doing business statistics for the destination country and One-Village’s home country as reported in the Doing Business 2017 report.


Required:
Advise the directors on four risks or issues One-Village should consider when deciding on whether to implement the proposed irrigation project in the destination country, and suggest how the risks or issues may be mitigated or resolved.
(8 marks for risks and mitigation)

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  • 12 Marks

AFM – Nov 2018 – L3 – Q1a – Discounted cash flow techniques

Evaluating an irrigation project using the Adjusted Present Value (APV) method, incorporating debt financing, government subsidy, and project cash flows.

One-Village Water Resources Ltd (One-Village) is considering a damming and irrigation project that will supply water to tomato farms around the Oti River. One-Village plans to commence the construction and installation phase of the project immediately and complete it in three years. One-Village will invest GH¢3 million in new plants and equipment now. Mobilisation to the project site will cost GH¢0.5 million now. Development costs are expected to be GH¢3 million in the first year, GH¢4 million in the second year, and GH¢2 million in the third year.

The commercial phase of the project will commence in the fourth year and run indefinitely. The project will generate after-tax net cash flows of GH¢6 million in the fourth year and GH¢8 million in the fifth year. Beyond the fifth year, cash flows will grow by 5% every year to perpetuity.

One-Village has 10 million shares outstanding, which are currently trading at GH¢3.5 each. The total value of its debt stock is GH¢20 million. One-Village plans to finance the investment requirements of the construction and installation phase of the project with new debt. Its borrowing cost is 20%, while its cost of equity is 25%. The Government of Ghana is promoting large-scale farming and is willing to give a subsidised loan of up to GH¢10 million at 15% annual interest. One-Village plans to take the maximum subsidised loan from the Government of Ghana and finance the balance with a bank loan. Issue costs, which are tax-deductible, are expected to be GH¢0.6 million. Both loans will be repaid in five years. One-Village falls into the 22% corporate income tax category. The risk-free interest rate is 14%, and the return on the market portfolio is 18%.

Required:
Evaluate the project using the adjusted present value (APV) technique and recommend whether it should be implemented or not. (12 marks)

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  • 6 Marks

AFM – May 2016 – L3 – Q4d – Sources of finance and cost of capital

Calculate the theoretical ex-right price, value of rights, and analyze the effects of a rights issue on a shareholder's wealth.

d) Agoro Limited has issued 75,000 equity shares of GH¢0.10 each. The current market price per share is GH¢24. The Company has decided to make a rights issue of one (1) new equity share at a price of GH¢16 for every four (4) shares held.

Required:
i) Calculate the theoretical ex-right price per share.

(2 marks)
ii) Calculate the theoretical value of the right. (1 mark)
iii) Mr. Crentsil currently holds 1,000 shares in Agoro Limited, show the effect of the rights issue on his wealth assuming he sells the entire right. (2 marks)
iv) Calculate the effect if Mr. Crentsil does not take any action and ignores the right issue. (1 mark)

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  • 6 Marks

AFM – May 2016 – L3 – Q4c – Emerging issues in finance and financial management, Regulatory framework and processes

Describe money laundering and identify risk-based approaches companies can use to combat it.

c) The growth of globalization has created more opportunities for free movement of capital/funds, which has resulted in a global canker called “money laundering.” There have been global efforts from governments and international institutions to combat the menace.

Required:
i) Describe in simple terms the concept of money laundering. (2 marks)
ii) Identify THREE risk-based approaches companies can adopt to combat the risk of money laundering. (4 marks)

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  • 5 Marks

AFM – May 2016 – L3 – Q4b – International investment and financing decisions, Economic environment for multinational organizations

Describe five strategic reasons that might motivate a company to undertake foreign direct investment. —------------------------------------------------------------------ Question: b) At the last meeting of the Board of Directors of Greenwich Ghana Limited, the Board resolved to establish a manufacturing facility in Asia and Europe. Briefly describe FIVE strategic reasons that might have informed management's decision to undertake the Foreign Direct Investment (FDI). (5 marks) Answer: Strategic Reasons for Foreign Direct Investment (FDI) Access to New Markets By establishing a manufacturing facility in foreign countries, the company gains access to new markets, enabling it to expand its customer base and increase market share. This helps diversify the company’s revenue sources and reduces dependency on the domestic market. (1 mark) Cost Reduction Manufacturing in regions with lower production and labor costs can significantly reduce operational expenses. Asia and Europe might offer cost advantages such as cheaper raw materials, lower wages, or favorable tax policies, making FDI a cost-effective decision. (1 mark) Proximity to Resources Setting up operations closer to key resources (such as raw materials or skilled labor) reduces transportation costs and ensures a more efficient supply chain. This proximity can also lead to better quality control and faster production cycles. (1 mark) Government Incentives Many countries offer incentives such as tax holidays, grants, or subsidies to attract foreign investments. These incentives can lower the company’s overall costs and improve profitability, making FDI an attractive option. (1 mark) Strategic Positioning Against Competitors Establishing a presence in key international markets can be a defensive move to counter competitors who are already operating in those regions. By entering these markets, the company can strengthen its competitive position and ensure it does not lose out on potential opportunities. (1 mark) ========== Let me know if you'd like to proceed with the next part or have any further modifications! Describe five strategic reasons that might motivate a company to undertake foreign direct investment. —------------------------------------------------------------------ Question: b) At the last meeting of the Board of Directors of Greenwich Ghana Limited, the Board resolved to establish a manufacturing facility in Asia and Europe. Briefly describe FIVE strategic reasons that might have informed management's decision to undertake the Foreign Direct Investment (FDI). (5 marks) Answer: Strategic Reasons for Foreign Direct Investment (FDI) Access to New Markets By establishing a manufacturing facility in foreign countries, the company gains access to new markets, enabling it to expand its customer base and increase market share. This helps diversify the company’s revenue sources and reduces dependency on the domestic market. (1 mark) Cost Reduction Manufacturing in regions with lower production and labor costs can significantly reduce operational expenses. Asia and Europe might offer cost advantages such as cheaper raw materials, lower wages, or favorable tax policies, making FDI a cost-effective decision. (1 mark) Proximity to Resources Setting up operations closer to key resources (such as raw materials or skilled labor) reduces transportation costs and ensures a more efficient supply chain. This proximity can also lead to better quality control and faster production cycles. (1 mark) Government Incentives Many countries offer incentives such as tax holidays, grants, or subsidies to attract foreign investments. These incentives can lower the company’s overall costs and improve profitability, making FDI an attractive option. (1 mark) Strategic Positioning Against Competitors Establishing a presence in key international markets can be a defensive move to counter competitors who are already operating in those regions. By entering these markets, the company can strengthen its competitive position and ensure it does not lose out on potential opportunities. (1 mark) ========== Let me know if you'd like to proceed with the next part or have any further modifications! Describe five strategic reasons that might motivate a company to undertake foreign direct investment.

b) At the last meeting of the Board of Directors of Greenwich Ghana Limited, the Board resolved to establish a manufacturing facility in Asia and Europe. Briefly describe FIVE strategic reasons that might have informed management’s decision to undertake the Foreign Direct Investment (FDI). (5 marks)

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  • 10 Marks

AFM – May 2018 – L3 – Q5b – Hedging against financial risk: Non-derivative techniques

Explaining exchange exposure and methods for minimizing and hedging against both pre- and post-acceptance exposure.

i) Explanation of Exchange Exposure (2 marks):

Exchange exposure refers to the risk that a company’s financial performance or position may be affected by fluctuations in exchange rates between currencies. For an exporter quoting prices in a foreign currency, there is a risk that the value of the foreign currency may change before payment is received, leading to a gain or loss in the value of that payment when converted into the company’s domestic currency.

Exchange exposure is classified into three types:

  • Transaction Exposure: Risk arising from actual transactions involving foreign currency payments or receipts.
  • Translation Exposure: Risk from converting foreign subsidiaries’ financial statements into the parent company’s reporting currency.
  • Economic Exposure: Risk from the overall impact of exchange rate changes on a firm’s future cash flows and market value.

(2 marks)

ii) Methods for Minimizing Pre-Acceptance Exposure (4 marks):

Pre-acceptance exposure arises in the period between the time an exporter quotes a price in a foreign currency and the time the contract is accepted.

Two methods to minimize pre-acceptance exposure:

  1. Time-Limited Quotes:
    • The exporter can limit the validity period of the quote to a short timeframe, ensuring that the exchange rate does not fluctuate significantly before the contract is accepted.
    • Advantage: This method reduces the period during which the exchange rate risk exists, thus minimizing potential exposure to currency fluctuations.
  2. Forward Contracts:
    • The exporter can lock in a forward contract to sell the foreign currency at a predetermined rate when the quote is accepted. This ensures that the company knows exactly what exchange rate will apply, regardless of fluctuations.
    • Advantage: A forward contract provides certainty about the future exchange rate, allowing the exporter to avoid potential losses due to unfavorable exchange rate movements.

(2 marks for each method, 4 marks total)

iii) Hedging Methods for Post-Acceptance Exposure (4 marks):

Post-acceptance exposure arises after the contract has been accepted but before the payment has been received. There are several methods for hedging this exposure:

  1. Borrowing in the Foreign Currency:
    • The exporter can borrow the foreign currency equivalent of the receivable immediately and repay the loan once the foreign customer pays. This hedges the risk of adverse currency movements.
    • Advantage: This method is relatively simple and cheap. It also provides immediate cash flow in the foreign currency and eliminates exchange rate risk.
  2. Forward Contracts:
    • The exporter can enter into a forward contract to sell the expected foreign currency receipt at a specified rate on the date payment is due. This locks in the exchange rate and eliminates the uncertainty associated with currency fluctuations.
    • Advantage: Forward contracts offer certainty about the amount of the domestic currency that will be received, providing security and allowing for better financial planning without committing cash resources upfront.

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