Subject: FINANCIAL MANAGEMENT

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FM – Nov 2024 – L2 – Q5c – Public-Private Partnerships (PPP)

Discuss types of PPP arrangements and their suitability for a highway project.

Question

Public-Private Partnerships (PPP) involve collaboration between government and a private sector company that can be used to finance, build and operate projects. Financing a project (for example, a highway) through PPP can allow a project to be completed sooner or make it a possibility in the first place.

Required:
Given the following types of PPP arrangements, discuss each of them and how they can be suitable for a highway project:

i) Build-Operate-Transfer (BOT)
ii) Design-Build-Finance-Operate (DBFO)
iii) Service Concession

Answer

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Tags: BOT, DBFO, Infrastructure Financing, Public-Private Partnerships, Service Concession
Level: Level 2

Topic: Public-Private Partnerships (PPP)
Series: Nov 2024

FM – Nov 2024 – L2 – Q5b – Overdue Debt Collection

Steps to collect overdue debts in financial management.

Question

Outline the steps to be followed to collect overdue debts.

Answer

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Tags: Credit control, Debt Collection, Financial management, Late Payments, Payment Recovery, Receivables
Level: Level 2

Topic: Management of receivables and payables
Series: Nov 2024

FM – Nov 2024 – L2 – Q5a – Management of Receivables

Evaluate the financial implications of different strategies for managing Abaa LTD's accounts receivable.

Question

Abaa LTD, a company that manufactures and sells electronic appliances, has been facing challenges with its accounts receivable management. Currently, the company allows its customers 60 days of credit. Due to the highly competitive market, Abaa LTD has been experiencing an increasing amount of bad debts and delayed payments, which has adversely affected its cash flow and profitability. To address these issues, the company’s Finance Manager is considering several strategic changes:

Reduction in Credit Period: Reducing the credit period from 60 days to 45 days. It is estimated that this change could reduce sales by 5% due to the stricter credit terms, but it would also decrease the bad debt ratio from 4% to 2% of sales.
Offering Early Payment Discounts: Introducing a 2% discount for customers who pay within 30 days. The company anticipates that 30% of its customers will take advantage of this discount, which would improve cash flow and reduce the average collection period by 15 days.
Engagement of a Factor: The company is also considering engaging a factoring company to manage its receivables. The factor would advance 80% of the invoice value upon the sale of goods at 200 basis points below the company’s cost of capital and charge a 3% fee on all sales. The factor is expected to reduce the bad debt ratio to 1% of sales and further reduce the average collection period by 20 days. Engaging the factor will lead to annual administrative savings of GH¢90,000.

Abaa LTD’s current annual sales are GH¢20 million, and the variable cost of sales is 60% of sales. The company’s cost of capital is 12% per annum.

Required:
Evaluate the financial implications of the following:
i) Reduction in Credit Period
ii) Offering Early Payment Discounts
iii) Engagement of a Factor
iv) Recommend the appropriate method to manage the credit sales

Answer

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Tags: Accounts Receivable, Bad Debts, Cash Flow, Cost of Capital, Credit Period, Early Payment Discounts, Factoring, Working Capital
Level: Level 2

Topic: Management of receivables and payables
Series: Nov 2024

FM – Nov 2024 – L2 – Q4b – Procurement and Tendering Procedures

Discuss circumstances under which single-source procurement is appropriate and functions of the Entity Tender Committee.

Question

The Farms and Gardens Authority (FGA), a public entity, wants to buy 100 computers and 20 printers for its administrative offices. The Chief Executive Officer (CEO) is considering using the single-source procurement method to procure the computers and printers while pushing back on the recommendations of the Entity Tender Committee.

Required:

i) State TWO circumstances under which single-source procurement would be appropriate for the goods the FGA wants to procure.

ii) Advise the CEO on TWO functions the Entity Tender Committee is expected to perform in the FGA’s procurements.

Answer

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Tags: Procurement, Procurement Laws, Public Financial Management, Public Sector, Single source procurement, Tender Committee, Tendering
Level: Level 2

Topic: Public sector financial management reforms
Series: Nov 2024

FM – Nov 2024 – L2 – Q4a – Business Valuation

Valuing a company using the discounted cash flow model and price multiples.

Question

Djokoto PLC (Djokoto) has 12 million ordinary shares outstanding and no other long-term debt. The Finance Director of Djokoto, Adepa, estimates that Djokoto’s free cash flows at the end of the next three years will be GH¢0.5 million, GH¢0.6 million, and GH¢0.7 million, respectively. After Year 3, the free cash flow will grow at 5% yearly forever. The appropriate discount rate for this free cash flow stream is determined to be 15% annually.

In a separate analysis based on ratios, Adepa estimates that Djokoto will be worth 10 times its Year 3 free cash flow at the end of the third year. Adepa gathered data on two companies comparable to Djokoto: Mesewa and Dunsin. It is believed that these companies’ price-to-earnings, price-to-sales, and price-to-book-value per share should be used to value Djokoto.

The relevant data for the three companies are given in the table below:

Variables	Mesewa	Dunsin	Djokoto
Current Price Per Share	7.20	4.50	2.40
Earnings Per Share	0.20	0.15	0.10
Revenue Per Share	3.20	2.25	1.60
Book Value Per Share	1.80	1.00	0.80

Required:
i) Estimate Djokoto’s fair value based on the discounted cash flows model. (5 marks)
ii) Compute the following ratios for the comparable companies:

P/E Ratio (2 marks)
Price-to-Sales Ratio (2 marks)
Price-to-Book-Value Ratio (2 marks)
iii) Based on the valuation results, discuss whether an investor should buy, sell, or hold Djokoto shares. Justify your recommendation. (4 marks)
iii) Identify two advantages and two disadvantages of business combinations.

Answer

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Tags: Business Valuation, Discounted Cash Flow, Financial Modelling, Price-Earnings ratio, Price-to-Book Ratio, Price-to-Sales Ratio
Level: Level 2

Topic: Business valuations
Series: Nov 2024

FM – Nov 2024 – L2 – Q3b – Mobile Money vs Traditional Banking

Discuss the disadvantages of mobile money compared to traditional banking services.

Question

The development of mobile money in Ghana has provided a section of the population with banking services that were previously not accessed. This expansion in financial inclusion is seen as a positive step towards boosting economic activity and alleviating poverty. However, there are some disadvantages to mobile money compared to a traditional bank account.

Required:
Explain FOUR disadvantages of mobile money compared to a traditional bank account.

Answer

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Tags: Banking Services, Financial Inclusion, Financial Literacy, Mobile Money, Regulation, Traditional Banking, Transaction Fees
Level: Level 2

Topic: Treasury management
Series: Nov 2024

FM -NOV 2024 – L2 – Q3a – Foreign Exchange Risk Management

Explaining foreign exchange risk types and calculating the impact of forward contract hedging.

Question

a) Dadisen PLC manufactures and sells pharmaceutical products in Ghana. It imports a significant portion of its pharmaceutical inputs from the USA. However, it only sells its products in Ghana. The company is considering establishing its foothold in The Gambia, Liberia, and Sierra Leone markets.

i) Dadisen PLC reports its results in its home currency. It pays for its purchases from the USA in US dollars but receives payments for its sales in Ghana cedis. All sales from Gambia, Liberia, and Sierra Leone are expected to be transferred into US dollar accounts each week. On average, the company generally takes 90 days to pay its suppliers and receives payment from its debtors within 60 days. In paying its suppliers, the company relies on bank overdrafts at an annual rate of 10%.

Over the last few years, the company has found that sales have been quite predictable, and it has been possible to plan sales levels and purchases of goods in advance. However, the company does not have adequate management skills for its foreign currency exposure. As a result, the company has reported exchange rate losses since 2020. The company is currently considering whether the forex exposure could be better managed.

Required:

Describe the following types of foreign currency exposure, giving examples of how they could impact the financial statements of Dadisen PLC:

Transaction risk
Translation risk
Economic risk

ii) The company estimates that it will need to borrow $1 million in three months’ time for a period of six months but is concerned about expected fluctuations in the exchange rate. The company is considering hedging this exposure using a currency forward contract. The company’s banker, GCB, has agreed to sell the US dollar forward for 9 months at GH¢17 to the dollar.

Required:
Compute the effect of the currency forward transaction on profitability if the spot exchange rate in 9 months is:

GH¢22
GH¢15

Answer

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Tags: Currency Forward Contracts, Economic Risk, Foreign Exchange Risk, Hedging, Transaction Risk, Translation Risk
Level: Level 2

Topic: Foreign exchange risk and currency risk management
Series: Nov 2024

FM – Nov 2024 – L2 – Q2 – Investment Appraisal

Calculate the NPV of launching two new products, Agbui and Loloi, and advise on the investment decision.

Question

Santrofi PLC is a publisher that wants to expand its market share in magazine publications. The company plans to launch two new products, Agbui and Loloi, at the start of January 2025, which it believes will each have a 4-year life span. The sales mix is assumed to be fixed. The information below is relevant:

Expected sales volumes (units) for Agbui:

Year	1	2	3	4
Volume	30,000	55,000	50,000	15,000

The first year’s selling price and direct material costs for each Agbui unit will be GH¢31 and GH¢12, respectively. On the other hand, the company expects to sell 25% more Loloi units than Agbui. Both selling price and direct material cost of Loloi are expected to be 25% less than Agbui’s.
Incremental fixed production costs are expected to be GH¢500,000 in the first year of operation, apportioned based on revenue. Advertising costs will be GH¢250,000 in the first year of operation and then GH¢125,000 per year for the following two years.
To produce the two products, an investment of GH¢1 million in machinery and GH¢500,000 in working capital will be needed, payable at the start of the period. Santrofi PLC expects to recover GH¢600,000 from the sale of machinery at the end of the project life. Investment in machinery attracts a 100% first-year tax-allowable depreciation. The company has sufficient profit to take full advantage of the allowance in Year 1. For the purpose of reporting accounting profit, the company depreciates machinery on a four-year straight-line basis.
Revenue and costs are expected to be affected by inflation after the first year as follows:
- Selling price: 3% a year
- Direct material cost: 3% a year
- Fixed production cost: 5% a year
The company’s real discount rate is 10% for investment appraisal. Average inflation is deemed to be 3%. The applicable corporate tax rate is 25%.

Required:
Calculate the Net Present Value (NPV) of the proposed investment in the two products and advise the company on its investment appraisal.

Answer

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Tags: Corporate Tax, Discounted Cash Flow, Inflation, Investment Appraisal, Machinery Investment, Net Present Value
Level: Level 2

Topic: Introduction to Investment Appraisal
Series: Nov 2024

FM – May 2016 – L3 – Q7 – Financing Decisions and Capital Markets

Comparing the cost of financing equipment replacement through an outright purchase funded by a loan versus a finance lease.

Question

MK Plc is considering the best way to finance the replacement for a particular high specification piece of equipment that has become too costly to maintain. The replacement equipment is estimated to have a useful life of 4 years with no residual value after that time.

Two alternative financing schemes are being evaluated:

Scheme A: Buy the equipment outright funded by a bank loan
Scheme B: Enter into a four-year finance lease

Scheme A: Buy outright, funded by a bank loan
MK Plc could purchase the equipment outright at a cost of N200 million on July 1, 2016. MK Plc can normally borrow at an annual interest rate of 13% per year.

Scheme B: Four-year finance lease
The equipment would be delivered on July 1, 2016, and MK Plc would pay a fixed amount of N58,790,000 each year in advance, starting on July 1, 2016, for four years. At the end of four years, ownership of the equipment will pass to MK Plc without further payment.

Other Information:

MK Plc has a cost of equity of 20% and WACC of 16%
MK Plc is liable to company tax at a marginal rate of 30%, which is settled at the end of the year in which it arises
Tax depreciation allowances on the full capital cost are available in equal instalments over the first four years of operation

You are required to:

a.

Calculate which payment method is expected to be cheaper for MK Plc and recommend which should be chosen solely on the present value of the two alternatives as at July 1, 2016. (13 Marks)

b.

Discuss the appropriateness of the discount rate used in (a). (2 Marks)

Answer

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Tags: Discount rate, Equipment Financing, Financing, Lease, Loan, Present Value
Level: Level 3

Topic: Financing Decisions and Capital Markets

FM – May 2016 – L3 – Q6b – Investment Appraisal Techniques

Calculating the betas, required rates of return, and stock prices for three securities based on market data and forecasts.

Question

The expected return on the market portfolio (estimated from past data) is 12% p.a. with a standard deviation of 15% and the risk-free rate of 4% p.a. The actual prices, last year dividends, and the covariances from three securities (A, B, C) with the market are given in the table below:

Security	Actual Price (N)	Last Year Dividend (N)	Covariance with Market
A	107	1.30	0.025650
B	618	18.00	0.018675
C	1,350	22.00	0.029025

You are required to:

i.

Calculate the betas and the required rates of return of securities A, B, and C. (3 Marks)

ii.

In the table below, you have the market consensus forecast of 12-month price targets, ex-dividends, and the expected dividend growth rate of the securities.

Security	12-month price target (N)	Dividend growth rate (%)
A	122.50	12
B	740.00	10
C	1,500.00	11

Assuming the dividends are paid in 12 months exactly, compute the required stock price for the 3 stocks and state your conclusion. (4 Marks)

iii.

Considering the results in (ii) above, explain briefly what will be your strategy? (1 Mark)

Answer

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Tags: Beta, CAPM, Dividends, Market Portfolio, Required Return, Stock valuation
Level: Level 3

Topic: Investment Appraisal Techniques

FM – Nov 2018 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for machine acquisition using present value and compare traditional financing with Islamic finance.

Question

Tamilore Limited (TL) is an agro-based firm, specializing in yam and rice production in Benue State of Nigeria. One of the harvesters is due to be replaced on November 30, 2018, the last day of TL’s current financial year. An investment appraisal exercise has recently been completed which confirmed that it is financially beneficial to replace the machine at this point. TL is now considering how best to finance the acquisition of the harvester to be replaced. TL is already highly geared.

A government development agency has offered the following two alternative methods of financing the machine:

Alternative 1
A loan of N49,200,000 at 6% interest rate to buy the machine on November 30, 2018. If this option is selected, the machine will be depreciated on a straight-line basis over its estimated useful life of 5 years.

Alternative 2
Enter into a finance lease. This will involve payment of annual rental of N12 million with the first payment due on November 30, 2019. The lease payments will be for the entire estimated useful life of the machine, which is 5 years, after which ownership will pass to TL without further payment.

Other information

(i) Whether leased or purchased outright, maintenance would remain the responsibility of TL and would be N450,000 payable annually in advance.
(ii) TL is liable to tax at a rate of 25%, payable annually at the end of the year in which the tax charge or tax saving arises.
(iii) TL is able to claim capital allowances on the full capital cost of the machine in equal installments over the first four years of the machine.
(iv) Assume that TL has sufficient taxable profits to benefit from any savings arising therefrom.
(v) All workings in N’000.

Required:

a. Show that the implied interest rate in the lease agreement is 7%. (3 Marks)

b. Advise, using present value method, whether Tamilore Limited should borrow to buy the machine or lease it. (12 Marks)

c. Instead of lease financing, one director has suggested an equivalent Islamic finance.

i. Explain briefly the principles of Islamic finance. (2 Marks)

ii. Explain three main advantages of Islamic finance. (3 Marks)

Answer

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Tags: Capital allowances, Financing decisions, Investment Appraisal, Islamic Finance, Lease vs Buy, Present Value Analysis, Tax implications
Level: Level 3

Topic: Financing Decisions and Capital Markets

FM – Nov 2018 – L3 – Q1 – Financial Strategy Formulation

Appraisal of a diversification project into holiday travel using WACC and associated financial strategy considerations.

Question

Eko Plc. (Eko) is a listed company in the food retailing sector and has large stores in all major cities in the country. Eko’s board is considering diversifying by opening holiday travel shops in all of its stores.

At a recent board meeting, the directors discussed how the holiday travel shops project (the project) should be appraised. The sales director insisted that Eko’s current weighted average cost of capital (WACC) should be used to evaluate the project, as the majority of its operations will still be in food retailing. The finance director disagreed, stating that the existing cost of equity does not account for the systematic risk of new projects and that the company’s overall WACC would change as a result of the project’s acceptance. The board was also concerned about the market’s reaction to its diversification plans. Another board meeting was scheduled, at which Eko’s advisors would be asked to make a presentation on the project.

You work for Eko’s advisors and have been asked to prepare information for the presentation. You have established the following:

Eko intends to raise the capital required for the project in such a way as to leave its existing debt-to-equity ratio (by market value) unchanged following the diversification. Extracts from Eko’s most recent management accounts are shown below:

Statement of financial position as at May 31, 2017

On May 31, 2017, Eko’s ordinary shares had a market value of 276 kobo (ex-div) and an equity beta of 0.60. For the year ended May 31, 2017, the dividend yield was 4.2%, and the earnings per share were 25 kobo. The return on the market is expected to be 8% p.a, and the risk-free rate is 2% p.a.

Eko’s debentures had a market value of N108 (ex-interest) per N100 nominal value on May 31, 2017, and they are redeemable at par on May 31, 2021.

Companies operating solely in the holiday travel industry have an average equity beta of 1.40 and an average debt-to-equity ratio (by market value) of 3:5. It is estimated that if the project goes ahead, the overall equity beta of Eko will be made up of 90% food retailing and 10% holiday travel shops.

Assume that the income tax rate will be 20% p.a. for the foreseeable future.

Required:

a. Ignoring the project, calculate the current WACC of Eko using:
i. The Capital Asset Pricing Model (CAPM) (8 Marks)
ii. The Gordon Growth Model (6 Marks)

b. Use the CAPM to calculate the cost of equity that should be included in a WACC suitable for appraising the project and explain your reason. (5 Marks)

c. By calculating an overall equity beta and using the CAPM, estimate the overall WACC of Eko assuming that the project goes ahead and comment on the implications of a permanent change in the overall WACC. (5 Marks)

d. Advise whether Eko should diversify its operations and how the stock market might react to the proposed project. (3 Marks)

e. Identify the appropriate project appraisal methodology that should be used when a project’s financing results in a major increase in a company’s market gearing ratio, and using the data relating to Eko, calculate the project discount rate that should be used in this circumstance. (3 Marks)

Answer

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Tags: Debt-equity ratio, Diversification, Financial strategy, Food Retailing, Holiday Travel, Management Decision, Project Appraisal, WACC
Level: Level 3

Topic: Financial strategy formulation

FM – Nov 2023 – L1 – SC – Q7 – Corporate Governance and Financial Strategy

Analyze FP’s dividend payout impact on stock price using forward P/E ratio, ROE, and sustainable growth rate.

Question

Ope plc has N10m 5 percent convertible bonds in issue. The option to convert into 40 N1 ordinary shares is open only for one more year; they must be either converted in one year’s time or left as ordinary bonds until nine years’ time when they will be redeemed at par. The current share price is ₦1.60, and the annual growth rate in the share price is 15 percent per annum. The current required return on Ope’s equity is 25 percent, its business being relatively risky.

The current yield on ordinary non-convertible bonds in similar companies is 11 percent. These interest rates are expected to remain constant.

Ife plc has 100,000 warrants outstanding, each entitling the holder to subscribe for one N1 ordinary share at 90 kobo any time during the next 3 years. The current share price is 57 kobo, and the capital growth is expected to be constant at 12 percent p.a. in the future. The current price of the warrant is 10 kobo.

Required:

a. Calculate the current value of Ope’s convertibles as straight debt, i.e., ignoring the option to convert and the value if conversion were to take place today. Would you expect the market value of the convertible to be above or below each of these amounts and why? (5 Marks)

b. By how much should the share price of Ope Plc rise before holders would be induced to convert, on the last possible date for conversion? (4 Marks)

c. Explain why the market value of a convertible bond is likely to be affected by the dividend policy of the issuing company. (4 Marks)

d. Based on the projected capital growth for Ife Plc, would you expect holders of the warrants to exercise them before expiry? What is the minimum annual growth rate of the share price necessary to induce holders to exercise their warrants? (2 Marks)

(Total 15 Marks)

Answer

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Tags: CAPM, Dividend Payout, DuPont Analysis, Forward P/E, Return on Equity, Sustainable Growth Rate
Level: Level 3

Topic: Corporate Governance and Financial Strategy
Series: NOV 2023

FM – Nov 2023 – L1 – SC – Q6 – Corporate Governance and Financial Strategy

Explain conflicts of interest between shareholders and managers and assess the impact of lower interest rates on a typical company.

Question

a. State and explain examples of conflicts of interest that may exist between shareholders and managers. (9 Marks)

b. Explain the likely implications for a typical company of lower interest rates. (6 Marks)

Answer

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Tags: Agency Problem, Conflicts of Interest, Corporate Governance, Financial Implications, Interest rates, Managers, Shareholders
Level: Level 3

Topic: Corporate Governance and Financial Strategy
Series: NOV 2023

FM – Nov 2023 – L1 – SC – Q5 – Business Valuation Techniques

Calculate convertible bonds' value as debt, assess market expectations, and analyze conversion inducements and dividend policy effects on convertible bonds.

Question

Ope plc has N10m 5 percent convertible bonds in issue. The option to convert into 40 N1 ordinary shares is open only for one more year; they must be either converted in one year’s time or left as ordinary bonds until nine years’ time when they will be redeemed at par. The current share price is ₦1.60, and the annual growth rate in share price is 15 percent per annum. The current required return on Ope’s equity is 25 percent, as its business is relatively risky.

The current yield on ordinary non-convertible bonds in similar companies is 11 percent. These interest rates are expected to remain constant.

Ife plc has 100,000 warrants outstanding, each entitling the holder to subscribe for one N1 ordinary share at 90 kobo anytime during the next 3 years. The current share price is 57 kobo, and capital growth is expected to be constant at 12 percent per annum in the future. The current price of the warrant is 10 kobo.

Required:

a. Calculate the current value of Ope’s convertibles as straight debt, i.e., ignoring the option to convert, and the value if conversion were to take place today. Would you expect the market value of the convertible to be above or below each of these amounts, and why? (5 Marks)

b. By how much should the share price of Ope Plc rise before holders would be induced to convert on the last possible date for conversion? (4 Marks)

c. Explain why the market value of a convertible bond is likely to be affected by the dividend policy of the issuing company. (4 Marks)

d. Based on the projected capital growth for Ife Plc, would you expect holders of
the warrants to exercise them before expiry? What is the minimum annual
growth -rate of the share price necessary to induce holders to exercise their
warrants?
(2 Marks)

Answer

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Tags: Convertible Bonds, Convertible Securities, Debt and Equity, Market Value, Valuation, Warrants
Level: Level 3

Topic: Business Valuation Techniques
Series: NOV 2023

FM – Nov 2023 – L3 – SB – Q4 – Financial Risk Management

Assess whether debt or equity financing is more suitable for a business expansion and discuss related financial concepts.

Question

Xeco is considering a N15 million expansion to increase profit before interest and tax by 20%. Financial details for Xeco are as follows:

Item	Amount (N’000)
Profit before interest	13,040
Finance charges (interest)	(240)
Profit before tax	12,800
Taxation	(3,840)
Profit for the year	8,960

Financing Options:

Debt: Issue N15m in 8% loan notes, with each note at a nominal value of N100.
Equity: 1-for-4 rights issue at a 20% discount to current share price (N6.25/share). Xeco has 12 million shares outstanding.
Corporate tax rate: 30%.

Required:

a. Evaluate whether Xeco should finance the expansion with debt or equity. (10 Marks)
b. Explain the relationship between systematic and unsystematic risk. (5 Marks)
c. Discuss the assumptions made by the Capital Asset Pricing Model (CAPM). (5 Marks)

Answer

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Tags: CAPM, Debt Financing, Equity Financing, Rights Issue, Risk analysis, Systematic risk, Unsystematic Risk
Level: Level 3

Topic: Financial Risk Management
Series: NOV 2023

FM – Nov 2023 – L3 – SB – Q3 – Investment Appraisal Techniques

Calculate and compare NPV for two proposals involving equipment purchase vs. existing machinery for contract fulfillment.

Question

Niko Plc, a large equity-financed company, has a year-end of December 31. It must fulfill a contract in Abuja and has two proposals to choose from: Proposal A (purchasing new machinery) and Proposal B (using existing machinery).

Proposal A:

Outlay of N312,500,000 on December 31, 2023, for new plant and machinery.
Projected net cash inflows (before tax, in nominal terms):
- 2024: N200,000,000
- 2025: N275,000,000
- 2026: N350,000,000
Scrap value: N25,000,000 at end of 2026.

Proposal B:

Uses a machine with a net realizable value of N250 million, with an alternative sale value of N300 million on January 1, 2025, if unused.
Cash inflows (in nominal terms):
- 2024: N350,000,000
- 2025: N350,000,000
Labour costs:
- 2024: N100 million (replacement staff cost of N110 million)
- 2025: N108 million (replacement staff cost of N118.8 million)
Machine residual value: N0 at project end in 2025.

Additional Details:

Working capital: 10% of year-end cash inflows, released upon project completion.
Expected annual inflation rates: 2024 – 10%, 2025 – 8%, 2026 – 6%, 2027 – 5%.
Real cost of capital: 10%.
Income tax: 40%, payable one year after the accounting period.
Capital allowances: 20% reducing balance for Proposal A’s plant and machinery.

Required:

a. Calculate the NPV at December 31, 2023, for each proposal. (17 Marks)
b. State any reservations about making an investment decision based on these NPV figures. (3 Marks)

Answer:

Answer

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Tags: Capital Allowance, Cash Flow, Discount rate, Investment Appraisal, NPV, Project evaluation
Level: Level 3

Topic: Investment Appraisal Techniques
Series: NOV 2023

FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

Question

About one year ago, you were employed by Tesco, an American company based in New York. You work online from home in Nigeria and are a member of the international treasury of Tesco.

Tesco supplies medical equipment to the USA and Europe and also buys some basic raw materials from Europe. It is currently 30 November 2024. On 31 May 2025, Tesco is due to receive CHF16.3 million from a Swiss customer and also to pay CHF4.0 million to a Swiss supplier.

Exchange rates (quoted as US$/CHF1):

Spot: 1.0292 – 1.0309
Three months forward: 1.0322 – 1.0341
Six months forward: 1.0356 – 1.0378

Annual interest rates available to Tesco:

Switzerland: 3.2% (investing), 4.4% (borrowing)
USA: 4.6% (investing), 5.8% (borrowing)

Currency futures (contract size CHF125,000, futures price quoted as US$ per CHF1):

Future price: December – 1.0306, March – 1.0336, June – 1.0369

Currency options (contract size CHF125,000; exercise price quotation US$ per CHF1, premium in US cents per CHF1):

Calls				Puts
	Dec	Mar	June	Dec	Mar	June
1.0375	0.47	0.50	0.53	0.74	0.79	0.86

Required:

a. Calculate the net receipt if hedged using a forward contract. (4 Marks)
b. Calculate the net receipt if hedged using money market hedging. (8 Marks)
c. Calculate the net receipt if hedged using futures. (10 Marks)
d. Calculate the net receipt if hedged using options. (8 Marks)
(Total: 30 Marks)

Answer

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Tags: Foreign Exchange, Forward Contract, Futures, Hedging, Money market, Options
Level: Level 3

Topic: Foreign Exchange Risk Management
Series: NOV 2023

FM – Nov 2023 – L1 – SA – Q1 – Mergers and Acquisitions

Evaluate Finkex Plc's acquisition strategy of Toba Plc, focusing on share-for-share impact, valuation methods, and shareholder implications.

Question

Finkex Plc (FP) is a listed company that operates in the pharmaceutical sector, manufacturing a broad range of drugs under license in a number of countries along the ECOWAS sub-region. For a number of years, the company has grown organically.

Three years ago, the company acquired 20% of the issued share capital of Toba Plc (TP) for N110 million, as a route to both expansion and diversification. The acquisition was by private negotiation in exchange for an issue of its own shares.

Toba Plc is involved in a different area of the pharmaceutical sector from FP as it is primarily a research-driven company involved in the development of new drugs.

To expedite the realization of its diversification strategy, the directors of FP have now decided to acquire the remaining 80% of Toba’s share capital.

Extracts from the financial statements of Finkex Plc are given below:

Finkex Plc – Extracts from financial statements for the last two years

Year	2023	2022
N’m	N’m
Non-current assets (including investment in Toba plc)	602.8	499.4
Current assets	265.0	180.4
Total Assets	867.8	679.8
Current liabilities	199.2	136.8
Total assets less current liabilities	668.6	543.0
Non-current liabilities	149.5	159.4
Net assets	519.1	383.6
Issued share capital (ordinary shares of ₦1 each)	100.0	73.6
Share premium	84.0	12.4
Profit or loss account	335.1	297.6
Total Equity	519.1	383.6
Sales revenue	1320.6	496.0
Earnings after tax	51.50	37.60
Dividend	14.0	14.0
Retained profits	37.5	23.6

All that is known about Toba Plc is that it has 114 million shares in issue; total share capital and reserves are N684 million; earnings after tax in the most recent year were ₦85.2 million on sales of N1,252.0 million, which were double those of the previous year; and that it has an investment valued at N80 million (book and market) in a type of enterprise which might not be of interest to Finkex Plc.

The current stock market prices per share are: Finkex Plc 300k; Toba plc 341k. Both companies pay tax at 50%.

Required:

a. At the above market prices, how many shares of Finkex Plc would have to be issued to buy the rest of Toba Plc on a share-for-share offer? (4 Marks)

b. With regard to earnings and also the book value of assets per share, how would the above share-for-share offer affect the position of:

i. Existing shareholders in Finkex Plc; (6 Marks)

ii. The 80% shareholders in Toba Plc whose shares were to be acquired? (4 Marks)

c. Assuming that the 80% shareholders in Toba Plc were prepared to accept ₦80 million 10% Loan Stock as part of the consideration:

i. What advantages might there be for Finkex Plc in this arrangement? (2 Marks)

ii. What total price could Finkex Plc afford to pay without diluting the earnings per share of its existing shareholders, as calculated in (b) (i) above? (6 Marks)

d. If the board of Toba Plc decided to advise its shareholders not to accept an offer from Finkex Plc, what arguments might they use – including any derived from the financial information available about Finkex Plc?

(8 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Earnings Per Share, Financial strategy, Loan Stock, Mergers and Acquisitions, Pharmaceutical Sector, Share-for-Share Offer, Shareholder Considerations, Valuation
Level: Level 3

Topic: Mergers and acquisitions
Series: NOV 2023

FM – Nov 2022 – L3 – Q7 – Corporate Governance and Financial Strategy

Analyze the Chairman's proposals to improve EPS and discuss methods to align stakeholder objectives.

Question

The Chairman of Opeyemi plc, a company listed on the Alternative Investment Market, has circulated a memorandum to the company’s directors and senior managers which contains the following statements:

“Looking to the year ahead, there are a number of measures which I propose to increase the company’s earnings per share (EPS).

Payments to trade creditors should be made as late as possible, even if this means extending our credit beyond the terms allowed by our suppliers. The company currently runs a substantial overdraft, and this measure will cut the level of bank interest and charges.

Relatively high capital expenditure in recent years has resulted in substantial depreciation charges in the profit or loss account. All capital spending, including that on the Oloro II project – designed to reduce toxic emissions from the manufacturing plant – should be postponed except where such spending can be shown to be essential to current operations.

Staff pay should be frozen at this year’s level for the forthcoming year. The company’s sponsorship of the local charity events run by the Staff Social Club should also, regrettably, be ended.

By boosting profits and therefore EPS, these measures will help us to achieve the highest possible stock market capitalisation.”

Required:

a. Prepare a response to the Chairman’s proposals which examines the possible consequences of the proposals for the price of the company’s shares and for the company’s stakeholders. (9 Marks)

b. Discuss FOUR ways that encourage managers to achieve stakeholder objectives. (6 Marks)

(Total 15 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Capital Expenditure, Cost Management, Delayed Payment, EPS, Stakeholder Management
Level: Level 3

Topic: Corporate Governance and Financial Strategy
Series: NOV 2022

Subject: FINANCIAL MANAGEMENT

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