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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  • 4 Marks

AFM – May 2018 – L3 – Q3a – Acquisitions and mergers versus other growth strategies

Discussing strategic issues that arise from pursuing growth through mergers, acquisitions, and organic growth.

Expansion by organic growth or by acquisition should only be undertaken if it leads to an increase in the wealth of the shareholders.

Required:
i) Discuss TWO strategic issues that arise from pursuing growth through mergers and acquisitions. (4 marks)
ii) Discuss TWO strategic issues that arise from pursuing growth through organic growth. (4 marks)

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  • 20 Marks

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

The Board of Peartek Ltd is considering the company’s capital investment options for the coming year, and is evaluating the following potential investments:

Investment A:

  • Investment of GH¢60,000, including GH¢40,000 for capital equipment and GH¢20,000 for increases in working capital.
  • Expected sales of 10,000 units next year with a sales price of GH¢10 and variable costs of GH¢6 per unit.
  • Sales price is expected to decline by 20% per annum due to competition, sales volume to fall by 10%, and variable costs to decline by 20%.
  • Overheads of GH¢15,000 annually, including a GH¢4,000 depreciation charge.
  • The project will be wound up in year three, with working capital recovered and capital equipment sold off for 25% of its cost.

Investment B:

  • Immediate outlay of GH¢90,000, financed by borrowing at 6%.
  • Expected net profits of GH¢12,000 next year, rising by 3% per annum indefinitely.

Investment C:

  • Outlay of GH¢25,000 financed by retained profits.
  • Expected annual net cash profits:
    • Years 1 to 4: GH¢3,000
    • Years 5 to 7: GH¢5,000
    • From year 8 onwards: GH¢7,000 in perpetuity.

The company discounts projects lasting 10 years or less at 10%, and others at 13%. Ignore taxation.

Required:

a) As a financial management analyst, you have been asked to advise the board of Peartek Ltd (in the form of a briefing report) which investment should be undertaken. Use the NPV method in your analysis. (15 marks)

b) Minority of board members feel that the Internal Rate of Return (IRR) should also be used as either an alternative or a complementary method of investment appraisal. Calculate the IRR of investments A and B and comment accordingly. (5 marks)

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  • 5 Marks

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

b) As a trading company, Joewoka exports and imports merchandise in many countries for which it receives and makes payment in foreign currency. This exposes the company to foreign exchange risk.

As a Financial Consultant to the company, suggest FOUR approaches that the company can use to hedge against foreign exchange exposure. (5 marks)

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  • 11 Marks

AFM – May 2016 – L3 – Q2a – Discounted cash flow techniques, Valuation and use of free cash flows, Theories of capital structure

Compute NPV for two investment projects using WACC and CAPM, and provide recommendations based on risk analysis.

a) Joebel Limited is a diversified company operating in different industries on the African Continent. The shares of the company are widely traded on the stock exchange and currently have a market price of GH¢3.20 per share. The company’s dividend payment over the last five years is as follows:

Year Dividend Per Share (DPS) (GH¢)
2015 0.35
2014 0.32
2013 0.30
2012 0.29
2011 0.28

The Board of Directors of Joebel Limited is considering two main investment opportunities: one in the Oil and Gas sector and the other in the Hotel and Tourism sector. Both projects have short lives and their associated cash flows are as follows:

Year Oil & Gas (GH¢’000) Hotel & Tourism (GH¢’000)
1 85 180
2 175 195
3 160 150

The investment in Oil and Gas would cost GH¢400,000, while the investment in Hotel and Tourism would cost GH¢405,000. The Management of the Company has identified the industry beta for Oil and Gas as 1.2 and for Hotel and Tourism as 1.6. However, Joebel Limited’s company beta is 1.5. The average return on companies listed on the stock exchange is 25%, and the yield on Treasury bills is 20%.

Required:
i) Compute the Net Present Values (NPV) of both projects using the company’s weighted average cost of capital as the discount rate. (5 marks)
ii) Compute the NPV using a discount rate that takes into account the risk associated with the individual projects. (5 marks)
iii) Advise Management regarding the suitability and acceptability of the projects. (1 mark)

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  • 3 Marks

AFM – May 2018 – L3 – Q1d – Theories of capital structure

Determining the required rate of return for Lime Spider Ltd’s shares using CAPM.

The market is currently yielding a return of 16% while Treasury bills are yielding 10%. Shares of Lime Spider Ltd have a covariance of 7.5 with the market, while the market has a variance of 4.5.

Required:
Determine the required rate of return for Lime Spider Ltd’s shares

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  • 5 Marks

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

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

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

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

Assuming no taxation and a 100% payout ratio:

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

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  • 10 Marks

AFM – May 2018 – L3 – Q1b – Sources of finance and cost of capital

Calculating the share price at which public and rights issues should be made and the share price expected after the rights issue.

Mbo Ltd needs to raise GH¢500,000 to finance a large-scale project which would produce earnings of GH¢90,000 in perpetuity but is undecided as to the manner in which the money should be raised.

The company has an issued capital of 2 million equity shares of GH¢1 each with a current market price of GH¢1.38 cum div. The annual dividend (which has been constant for many years) of GH¢360,000 is about to be paid.

Two methods of raising capital are being considered, a public issue, and a right issue at GH¢1.

Required:
i) Calculate the price at which the public issue should be made. (5 marks)
ii) Calculate the price at which you would expect shares to be valued immediately after the rights issue. (5 marks)

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  • 10 Marks

AFM – May 2016 – L3 – Q1b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives, The use of financial derivatives to hedge against interest rate risk

Explain how to hedge a foreign exchange risk exposure using forward and money markets with calculations.

b) A Ghanaian Food and Beverage company has recently imported raw materials from China with an invoice value of US$264,000 payable in three months’ time. Due to the company’s efficient production capacity, it has finished production and exported finished products to Germany. Consequently, the German customer has been invoiced for US$75,900 payable in three months’ time. Below is the current spot and forward rates for the transactions:

  • USD/GHS Spot: 0.9850 – 0.9870
  • 3 Months Forward: 0.9545 – 0.9570

Current Money Market rates per annum are as follows:

  • US$ (USD): 11% – 13.2%
  • Gh¢ (GHS): 12.7% – 14.3%

Required:
i) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure to foreign exchange risk using the Forward Markets. (3 marks)
ii) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure using the Money Markets. (4 marks)
iii) Determine which of the above markets is the best hedging technique. (3 marks)

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  • 2 Marks

AFM – May 2018 – L3 – Q1a – Economic environment for multinational organisations

Explaining strategic reasons for engaging in foreign direct investment (FDI).

There are many strategic reasons for Multinational Enterprises to undertake foreign direct investment (FDI) to stimulate economic activity in the host country.

Required:
Explain TWO strategic reasons for engaging in FDI. (2 marks)

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  • 10 Marks

AFM – May 2016 – L3 – Q1a – Discounted cash flow techniques, Sources of finance and cost of capital

Calculate the average rate of return for two stocks and analyze portfolio return using different methods.

a) Crown Limited 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 (%)
2010 -10 -3
2011 18 21
2012 39 44
2013 14 4
2014 33 28

Required:
i) Calculate the average rate of return for each stock during the period of 2010 to 2014. (3 marks)
ii) Calculate the average return on the portfolio during the period if Crown Limited held 50% each of stock A and stock B. (3 marks)
iii) Calculate the return of the portfolio using the standard deviation approach. (4 marks)

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